Document of

The World Bank

FOR OFFICIAL USE ONLYr *'t

Report No. 2273-ME

STAFF APPRAISAL REPORT

MEXICO

SECOND FERTILIZER PROJECT (LAZARO CARDENAS)

March 29, 1979

Industrial Projects Department

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

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CURRENCY EQUIVALENTS WEIGHTS AND MEASURES

Mex$ 1.0 = US$0.04 1 Meter = 39.37 inchesMex$22.5 = US$1.00 1 Metric Ton (ton or MT) = 1,000 kilograms

1 Kilogram (kg) = 2.205 pounds (lbs)1 Kilometer (km) = 0.62 milesI Hectare (ha) = 2.17 acresI Cubic Meter = 1 m = 35.3 cubic feet (cu. ft.)I Normal Cubic Meter of Gas (Nm ) = 37.3

Standard Cubic Feet of Gas (SCF)1 MSCF = 1,000 SCF

PRINCIPAL ABBREVIATIONS AND ACRONYMS USED

AN Ammonium NitrateAS Ammonium SulphateBANCRURAL Banco Nacional de Credito RuralCFE Comision Federal de ElectricidadCONASUPO Compania Nacional de Subsistencias PopularesDAP Diammonium PhosphateFFM Fertilizantes Fosfatados Mexicanos S.A.GDP Gross Domestic ProductFERTIMEX Fertilizantes Mexicanos S.A.IFDC International Fertilizer Development CenterIMP Instituto Mexicano del PetroleoK20 Potassium content in Fertilizerkw Kilowattkwh Kilowatt hourMW MegawattN NitrogenNAFINSA Nacional Financiera S.A.NPK Compound FertilizerP 0 Phosphatic content in FertilizerPEMEX Petroleos MexicanosPROFERSA Productos Basicos para Fertilizantes, S.A.ROFOMEX Roca Fosforica de MexicoSCF Standard Cubic FeetSICARTSA Siderurgica Lazaro Cardenas, S.A.SSP Single SuperphosphateTPD Tons per DayTPY Tons per YearTSP Triple Superphosphate

FISCAL YEAR

January 1 - December 31

FOR OFFICIAL USE ONLYMEXICO

SECOND FERTILIZER PROJECT (LAZARO CARDENAS)

TABLE OF CONTENTS

Page No.

I. INTRODUCTION ............................................ 1

II. THE FERTILIZER INDUSTRY .................................. 2

A. History and Structure of the Industry ............. . 2B. Raw Materials .................................... . 3

1. Sulfur ........................................ 32. Hydrocarbons .................................. 33. Phosphate Rock ................................ 4

C. Local Engineering and Construction Capabilities .... 4D. Production Capacity and Performance .... ............ 6E. Future Plans ....................................... 7F. Prior Bank Involvement ............................. 8

III. THE BORROWER AND PROJECT SPONSOR ........................ 9

A. Organization and Structure .... ............. 91. Corporate Charter and Organization .... ........ 92. Planning and Construction ..................... 103. Financial ..................................... 10

B. Manufacturing Facilities ..... ...................... 11C. Financial Situation ................................ 11D. Acquisition of Fertilizantes Fosfatados

Mexicanos (FFM) .................................. 14

IV. THE MARKET AND MARKETING SYSTEM ...... .................... 15

A. Agriculture in Mexico .............................. 15B. Fertilizer Use in Agriculture ...................... 17C. Hlistorical Fertilizer Demand and Supply Balance 19D. Projected Demand and Production of Fertilizers ..... 20E. Fertilizer Marketing and Distribution .... .......... 22

1. Project Marketing Area ........................ 222. Distribution System ........................... 223. Product Handling and Commissions .... .......... 244. Warehousing and Inventories .... ............... 245. Transport ..................................... 26

F. Fertilizer Prices and Pricing Policy ........ ....... 26

V. THE PROJECT .............................................. 29

A. Project Scope ...................................... 29B. Raw Materials, Utilities and Infrastructure ... ..... 30C. Technology and Engineering ......................... 31D. Project Management and Schedule .................... 32E. Environmental Aspects ............................... 32F. Employment and Training ............................ 34

This report was prepared by Messrs. Loos, Evans, Soncini and Bhan of theIndustrial Projects Department.

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

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Page No.

VI. PROJECT COST, FINANCING PLAN AND PROCUREMENT ............ 35

A. Capital Cost ................ O-* ................................... 35B. Financing Plan ..................................... 36C. Procurement ..... ....... ...... ................................ 37D. Allocation and Disbursement of Bank Loan ........... 38

VII. FINANCIAL ANALYSIS ......... ............. ..................... ... . 39

A. General .......................................................... 39B. Operating Cost of the Project .................. * ... 39C. Financial Projections for the Project ............. . 40

D. Financial Projections for the Company Consolidatedwith the Project ................................. 41

E. Financial Rate of Return and Sensitivity Analysis .. 43

F. Financial Covenants and Reporting Requirements .... 43

G. Major Risks ....................................... 44

VIII. ECONOMIC ANALYSIS ......... .... ..... .................. ................... 45

A. Economic Costs and Benefits ........................ 45B. Economic Rate of Return ..................... ..... 46C. Other Benefits and Foreign Exchange Savings ........ 47

IX. AGREEMENTS .............................................. 48

ANNEXES

3-1 FERTIMEX - Manufacturing Capacities and Production3-2 Financial Statements of FERTIMEX

4-1 Cultivated Crops by Regions4-2 Apparent Nutrient Consumption 1950-784-3 Crops and Fertilizer Usage Based on Average Fertilizer

Recommendations for 19754-4 Warehouses and Distribution Channels4-5 Terms of Reference for Fertilizer Distribution Study

4-6 Fertilizer Prices at Rail Depot

6-1 Capital Cost Estimate6-2 Permanent Working Capital6-3 Estimated Disbursement Schedule for Bank Loan

7-1 Assumptions Used in Financial Projections

7-2 Estimated Production Cost Summary and Output Value for 1985

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7-3 Financial Projections for the Project7-4 Financial. Projections for the Company Consolidated with the Project7-5 Cash Flows for Financial Rate of Return Calculati'ons

8-1 Assumptions Used in Econom:ic Analysis8-2 Economic Cost and Benefit Streams

CHARTS

C-1 Organization Chart of FERTIMEX

C-2 Organization Chart of the P'lanning and Developing DepartmentC-3 Organization Chart of the Finance DepartmentC-4 Comparative Fertilizer Demand Projections of FERI'IMEX and IFDCC-5 Lazaro Cardenas Project - Block Diagram

MAP IBRD 13550Mexico Marketing Regions and Location of Fertilizer PlantsIBRD 13548 - Plant LayoutIBRD 13549 - Project Area

DOCUMENTS AVAILABLE IN THE PROJECT FILE

Reference Title

A Feasibility Study, prepared by FERTIMEX, 1977

Volume I BackgroundVolume II Market StudyVolume III Technical AspectsVolume IV Financial and Economic StudyVolume V General Statistics concerning

Production and Consumption

B Market Evaluation of GUANOMEX' Lazaro Cardenas Project,prepared by J. M. Hill, IFDC, January 1978

C Various Documents concerning the Financial Status ofFERTIMEX, prepared by FERTI:MEX

D FFM Documents concerning merger with FERTIMEX,prepared by FERTIMEX, 1978

E Contract with Instituto Mexicano del Pe.troleo

F Contracts with Process Engineering Contractors

I

I. INTRODUCTION

1.01 The Government of Mexico (the Government) and Fertilizantes MexicanosS.A. (FERTIMEX, the Company) have requested Bank financing for a phosphaLtecompound fertilizer manufacturing project (the Project) to be built at LazaroCardenas in the state of Michoacan (NAP IBRD-13550). The proposed Bank loanof US$80 million will cover approximately 27% of the total estimated financingrequirements of US$301 million and about 64% of the total foreign excharLgecost of US$125 mill:ion. The remaining financing for the Project will be pro-vided in the form of new equity (US$95 million) to be subscribed by theGovernment, internally generated cash by FERTIMEX (US$26 million), bilateralfunds (US$5 million), and foreign commercial loans (US$95 million). The pro-posed loan would be the second Bank operation in the Mexican fertilizersector; FERTIMEX is currently implementing a nitrogenous fertilizer proJect(Report No. 734-ME, dated May 5, 1975) with the assistance of a US$50 millionBank loan.

1.02 The Project was prepared and will be implemented by FERTIMEX Eawholly-owned government corporation and the country's main producer and soledistributor of fertilizers (Project File -- Reference A). The Project willproduce approximately 275,000 tons per year (tpy) of diammonium phosphate(DAP); 250,000 tpy of compound fertilizers (NPK); 190,000 tpy of ammoniumnitrate (AN); and 10,000 tpy of marketable phosphoric acid, all for consump-tion in the domestic market. The major engineering contracts for the imple-mentation of the Project have already been awarded and registration of equip-ment suppliers and preparation of bidding specifications are presently inprogress to achieve commencement of commercial operations by October 1981.

1.03 The Project is designed to ensure that Mexico will have sufficientcapacity to meet expected increases in domestic phosphatic and nitrogenousfertilizers through the early 1980s and to partly correct the current imbalancein the Mexican fertilizer industry, which exports intermediate products suchas ammonia and phosphoric acid, while at the same time importing substantialquantities of finished fertilizers to meet domestic demand. The Project.involves building of a new finished fertilizers production complex at LaLzaroCardenas, a new industrial center on the Pacific coast, close to the mainfertilizer consuming regions of the country. It is an integral part of theGovernment efforts to stimulate the agriculture sector by making the countryself-sufficient in important agricultural inputs such as fertilizers, and tolocate important industrial projects away from major urban centers. TheProject, when in operation, will provide direct permanent employment for 630persons; additionally, during the construction period, job opportunities willbe provided in the Mexican equipment manufacturing, construction and designengineering industr:ies, all of which are expected to play major roles irLproject implementation.

1.04 The Project was first identified in October 1975 and was planned forconstruction at Guaymas, Sonora, adjacent to a planned new copper smeltingfacility of Mexicana de Cobre S.A. However, following deferment of the

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smelting project and installation of the new Government in December 1976,

FERTINEX (formerly known as GUANOMEX) reappraised the Project. This led

in mid-1977 to the Government granting top priority to the construction of

the Project at the present location (Lazaro Cardenas), with a 20% increased

production capacity (para 1.02). The Project, in its present form, was

pre-appraised in November/December 1977, and appraised in August 1978 byMessrs. Kurt Loos, Geoffrey Evans and Jose Soncini of the Industrial Projects

Department, assisted by Messrs. Delio Gianturco (financial consultant) and

John Hill (market consultant).

II. THE FERTILIZER INDUSTRY

A. History and Structure of the Industry

2.01 Until December 1977, the Mexican fertilizer industry consisted of anumber of small private blenders and three main Government-owned companies:

(i) Guanos y Fertilizantes S.A. (GUANOMEX); (ii) Fertilizantes FosfatadosMexicanos (FFM); and (iii) Petroleos Mexicanos (PEMEX). The attached map(IBRD-13550) shows the locations of various plants owned by these companies.

2.02 The country's largest producer of finished fertilizers and the sole

fertilizer marketing company, GUANOMEX, was originally created by PresidentialDecree in 1943 as a Government-owned enterprise to promote the use of organic

fertilizer, exploit the guano 1/ deposits on the Pacific Coast, and distributeguano products. In 1948, a second Decree broadened the scope of GUANOMEX'role into production and distribution of chemical fertilizers and, in the late

1950s, as a complement to GUANOMEX' activities, private investments in the

fertilizer sector were promoted. However, in 1965, the Government decided to

merge the three major private sector companies 2/ into GUANOMEX, with the

objective of streamlining the scattered and uncoordinated production anddistribution activities of the industry, in order to better promote andstimulate increased fertilizer use in Mexico. The Government policy toconsolidate the responsibilities for the supply of major agricultural inputs

also led, in the late 1960s, to the GUANOMEX take-over of the national supplyof insecticides, acquisition of a majority holding of Fertica S.A., whichowns fertilizer plants in Central America, and a minority participation (20%)in Azufrera Panamericana, the company engaged in exploitation of Mexico'ssulfur deposits. In addition, GUANOMEX was assigned the sole responsibilityfor domestic marketing and distribution of fertilizers.

2.03 FFM was the country's sole producer of phosphoric acid and triplesuperphosphate (TSP). Although majority-owned by Banco de Mexico, FFM was runalong private enterprise lines; it was nationalized in 1975 and brought under

1/ Organic fertilizer from bird droppings.2/ Fertilizantes de Monclova S.A. (AN, NPK); Fertilizantes del Istmo S.A.;

(AN, Urea, NPK), Fertilizantes de Bajio S.A. (Urea).

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the control of a state holding company, Productos Basicos para Fertilizantes(PROFERSA). FFM had become one of the world's largest exporters of phosphoricacid and also owned ships and interests in phosphate deposits in Florida. Inthe domestic market, FFM sold phosphoric acid and TSP to GUANOMEX for furtherconversion and distribution to farmers.

2.04 PEMEX -- also state-owned -- is the largest single industrial enter-prise in Mexico and is responsible for production and distribution of petroleumand basic petrochemical products. As a producer of basic petrochemicals,PEMEX is also responsible for the production and export of ammonia, whileGUANOMEX, which owned a small ammonia facility, was responsible for convertingit into solid fertilizers and for domestic ammonia distribution.

2.05 Following the latest restructuring of the fertilizer industry whichinvolved the integration of FFM's operations into FERTIMEX on January 1, 1978,the consolidated enterprise owns all of Mexico's fertilizer production capacityexcept for ammonia production which remains PEMEX' responsibility and a smallamount of ammonium sulfate production which remains in private hands. WhilePEMEX will retain responsibility for ammonia exports, FERTIMEX will be respons-ible for domestic marketing of ammonia and for exports and domestic marketingand distribution of all other fertilizer products. In addition, the Govern-ment uses FERTIMEX as an executing agency to administer Mexico's fertilizerimports and to provide -- together with other Government institutions --promotion and extension of fertilizer usage, as well as research and testingof soils.

B. Raw Materials

1. Sulfur

2.06 Mexico is well endowed with most of the raw materials required forfertilizer production, including sulfur, natural gas and recently discovereddeposits of phosphate rock. Only potash has not been found in economicallymineable quantities. Mexico's substantial reserves of sulfur are locatedmostly around the Gulf of Mexico and the Isthmus of Tehuantepec, with thelargest mines of the two major producing companies, Asufrera Panamericana S.A.and Compania Exploradora del Istmo, being located at Jaltipan and Texistipec,respectively. In 1976, Mexico produced about 2.2 million tons of sulfur,virtually all of it in the form of brimstone, making it the world's fifthlargest sulfur producer. In the same year, it exported somewhat over 1million tons, or about 10% of total world exports.

2. Hydrocarbons

2.07 Mexico has substantial hydrocarbon reserves. According to govern-ment estimates, released in July 1978, Mexico's proven oil reserves are equiv-alent to 20 billion barrels of oil, probable reserves are 37 billion barrelsand potential reserves are 200 billion barrels. At present consumptionrates, proven oil reserves, which include substantial amounts of associatedand non-associated gas, are expected to meet Mexico's needs well beyond theturn of the century. The main gas fields are in the State of Tabasco, in thenortheast near the US border, and in the State of Veracruz (MAP IBRD 13550).In 1977, gas production totalled about 750 billion of standard cubic feet

(SCF) of which approximately 60% was associated. At present, the mainproduction area is in Tabasco with about 70% of the total production, followedby the northeast and the State of Veracruz with about 20% and 10%, respectively.The gas is distributed and sold via two main pipeline networks. The Northernpipeline extends some 2,000 km from Matamoros, near the Gulf Coast, to Celulosade Chihuahua and the Southern pipeline leads from Ciudad-Pemex in Tabasco toGuadalajara in Jalisco, a distance of some 1,300 km. In 1977, sales throughthe Northern and Southern networks amounted to 125 billion SCF and 355 billionSCF, respectively. The balance of the total production of 750 billion SCF wasconsumed internally by PEMEX partly for the production of 945,000 tons ofammonia in that year.

2.08 Until 1976, PEMEX sold practically its entire ammonia productionlocally to FERTIMEX to be used, along with imported ammonia, as an input inits own finished fertilizer facilities or to be marketed for direct applica-tions in the agricultural sector and for industrial purposes. (The diagram onthe following page gives a more detailed supply flow and company interrela-tionship of the Mexican fertilizer industry from raw materials to intermediateand end products.) In 1977, PEMEX exported for the first time 30,000 tons ofammonia and signed further export contracts for the following years. PEMEXplans to greatly expand its production capacity, from about 1.4 million tonsof ammonia in 1977 to about 3.2 million tons in 1981. Part of the increasedammonia production will be absorbed by the growing domestic demand. A majorportion of the incremental output, however, is designed for export, utilizingsurplus natural gas as feedstock. Some of the ammonia earmarked for exportwould be converted to urea by FERTIMEX, to achieve a higher value added anddiversify markets.

3. Phosphate Rock

2.09 Until now, Mexico has imported its phosphate rock requirementsexcept for small quantities produced by two local companies, Minerales In-dustriales and Fosforitas Mexicana. However, the sharp rise in import pricesin 1974 prompted renewed exploration efforts which led to the discovery at SanHilario (some 60 km north of the city of La Paz in Baja California) of one ofthe world's largest phosphate rock deposits, with total reserves of 3,000 mil-lion tons estimated to average 12% P205 lying at a maximum depth of 40m (MapIBRD-13550). To develop these deposits, Roca Fosforica de Mexico (ROFOMEX)was established in July 1975 under the control of PROFERSA, a state holdingcompany responsible for the local development of non-hydrocarbon raw materialsfor fertilizer (para 2.03). Initially ROFOMEX plans to extract some 1.6 mil-lion tons of rock annually from a deposit near San Juan de la Costa, gradingan average P205 content of 18.8%, for the production of 600,000 tons of 29-30% concentrates; production is expected to start early in 1980. Ultimately,ROFOMEX plans to increase output to 3 million tons per year of concentrate,sufficient to supply all of Mexico's domestic requirements and to beginexports.

C. Local Engineering and Construction Capabilities

2.10 Mexico has well developed local engineering and construction capa-bilities and facilities for domestic equipment manufacturing, including for

MEXICO - LAZARO CARDENAS FERTILIZER PROJECT

BLOCK DIAGRAMMEXICAN FERTILIZER INDUSTRY

QUANTITIES SHOWN APPLY TO 1976

RAW MATERIALS INTERMEDIATE PRODUCTS END PRODUCT

' SI)LFUh ~~~~M/T %EXPLORADORA DEL ISTMO 129 2 55 4

AZUFRERA PANAMFRICANA 77 5 33 3 r SULFURIC ACID M/T A

PEMLX 26 3 1_1 3 GUANOMEX 534 0 346 6GA MX3 78

TOTAL 233 3 100 0 FFM799 0 sla_ UNIVEX 169 20v S

_ _ ASARCO MEXICANA 148 16 O _2

INDUSTRIA QUIMICA 10 12

_( PENOLES 179.5 115 TuTA; bi3 100.0~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~81 16

RIMPDTS 4.0 03

TOTAL 1543.3 100.0

SULFUR M,T

SULFUR | 273.0 _ b b ( S INGLE SUPER PhOSPhATE T M T

SULFUR MINERALS RDASTING | 116 0 3 , t GUANOMEX | 290 1 10UN7 0

PHOSPHATE ROAK M/T

MI ERALESINDUSTRIALES M/T-F~~~~~~~~~~~~PHSPORC dS M/ 5DUANOMES ~~~~ ~~147 10

FOSFDRITAS MEXICANAS 1 6 1.2 GUANOMEX 39 124

iMPORTS 1 32 9.8 | __ r F F M 276 87 8 ._ |

IMPORTS 71039 77 TOTAL 31b 100tTOTAL |1 340 | 100.0 TRIPLE SUPR HOSPTE _M,Tp b > t FPFM _ 216 |103

PHOSPHORIC ACI M/ 6

IMPORTAS 86/T 100O l COMPLEX FERTILIZER N4PK T E E N I

|GUANOMEX| 180 100

NATURAL GAS | U ) 865 AMMONIUM NITRATE KITPEMEX 00 GUANOMEX 160 10 GUANOMEX 140 100

| k TOTAL | 943 [ 1000 ) * § 3

I i F > C ~~~~ ~ ~~~~~~~~~~~~~~~~~~~UREAi lT U L

POTASSIUM SULFATE MT ULK 3

L [ ~~~~~~~~~~~~~~~~~~~~~~~~~~~DIHECT APPLICATION |M/T

FFRTIMEX ACQLJIRFE FFM IN JANUARY, 1978

M'T = THOUSANDS OF METRIC TONS I

[~~ PEMEX 0 .Ee |~~i8 1003

Vo,ldR r-k / 8842

Industrial Projec's DepartmentMarch 1979

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the oil, petrochemicals and fertilizer industry. It also has developed,particularly in the field of petrochemicals and refining, good expertise in

project planning, procurement and project execution largely as a result ofPEMEX' vast expansion program. For instance, Instituto Mexicano del Petroleo

(IMP) -- the largest local engineering company -- has reached international

standards and is recognized for its competence in plant design and generalproject coordination. Additionally, a number of private Mexican engineeringfirms have associated with leading foreign firms. Nevertheless, earlier

fertilizer projects, including that financed by the Bank (para 2.16), haveexperienced completion delays and cost increases partly due to a lack ofprior experience with similar large projects, inadequate coordination of

site activities and work scheduling, and delays in delivery of local con-struction materials (e.g., structural steel). However, major efforts have

been made by the project executing agencies to overcome such deficienciesand these have led to considerable improvement in the industry's performancein the recent past. Today, practically all detailed engineering and most

project coordination -- with some supervision by foreign contractors -- is

satisfactorily performed in the country.

2.11 The recent expansion of petrochemical and fertilizer capacities has

also helped further develop local equipment supply capabilities. Domesticmanufacturers provide a wide range of equipment and supplies for fertilizer

and chemical plants, often in collaboration with experienced foreign companies.

These include such items as steam boilers (with Combustion Engineering, US)and chemical process pumps (with Pignone, Italy). The development and use of

local capabilities for engineering, equipment supplies and plant constructionhas reduced the foreign currency portion of new fertilizer projects to about30-40% of total financing requirements.

D. Production Capacity and Performance

2.12 The table below shows the build-up of Mexico's fertilizer production

capacities by product during the last 25 years:

Mexico - Historical Development of Fertilizer Capacities 1953-1978(in '000 tons of product)

Averge AnnualGrowth Rates (%)

1953 1963 1973 1978 1963-78 1973-78IntermediatesAmmonia 20 150 590 2,080 19.2 28.7Phosphoric Acid - 120 610 610 11.5 -

Total Intermediates 20 270 1,200 2,690 16.6 17.5

Finished ProductsAmmonium Sulfate 225 225 605 805 8.9 5.9Ammonium Nitrates a/ - 178 178 178 - -

Urea - 358 433 433 1.3 -

Single Superphosphate 195 195 285 285 2.6 -Triple Superphosphate - - 270 270 n.a. -

Complex Fertilizer (NPK & DAP) - 190 270 270 2.4 -Total Finished Products 420 1,146 2,041 2,241 4.6 1.9

a/ Including ammonium nitrate solution.

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The major capacity expansions for finished products took place during the1960s and were until recently highly dependent on imported feedstocks. Themajor capacity increases for intermediaries came on stream later, i.e., in thelate 1960s in the case of phosphoric acid and in the mid-1970s for ammonia.The current capacity of both ammonia and phosphoric acid substantially exceedsthe requirements of domestic finished fertilizer facilities, leaving room forsubstantial exports. While, therefore, domestic finished fertilizer capaci-ties are insufficient to meet domestic market requirements necessitatingimports of finished products (urea, ammonium sulfate, ammonium nitrates,diammonium phosphate and complex fertilizer) Mexico at the same time exportsintermediates (para 4.10). The proposed Project has been designed to partlycorrect this imbalance.

2.13 In the recent past, Mexico's fertilizer industry has generallyoperated at high levels of capacity utilization as shown below:

Mexico -. Fertilizer Industry Capacity Utilization in 1978(in '000 tons of product)

Capacity Productiorr- Capacity Utilization(%)

IntermediatesAmmonia 2,080 a/ 1,600 77Phosphoric Acid (in P 205 tons) :330 304 92

Finished Products

Ammonium Sulfate 697 659 95Ammonium Nitrate (Solids) [35 110 81Urea 433 345 80Single Superphosphate :285 282 99Triple Superphosphate 270 223 83Complex Fertilizer (NPK & DAP) 270 322 119

a/ Average annual name plate capacity for the year.b/ Estimated.

The relatively low utilization of amrmonia capacity is due to the start-up oftwo new plants at Cosoleacaque (450,000 tpy) and at Salamanca (300,000 tpy)during 1978. The figures in the above table indicate a good performance! byFERTIMEX and PEMEX production managements.

E. Future Plans

2.14 As discussed in para 2.12 above, the domestic nutrient capacity/production has increased substantially during the last 15 years and furtherexpansions are under implementation. However, the increases are largely inammonia production, of which only limited amounts can be used for directapplication. Unless, after the completion of plants currently under imple-mnentation, substantial additional corLversion capacity is added, Mexico willincreasingly need to export intermediate fertilizers like ammonia while im-porting large quantities of finished fertilizers as discussed in para 4.10.

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The Government's future plans for the fertilizer industry, of which theProject forms an important part, aim at resolving the current imbalance ofthe capacities, not only to improve the country's balance of payments butalso to provide its agricultural sector with an assured supply of a betterfertilizer slate than in the past at economic prices.

2.15 For phosphatic fertilizers the situation differs somewhat from thatof nitrogenous fertilizer. Unless further capacities are added, the surplusquantities of phosphoric acid and TSP presently available for exports areexpected to decrease rapidly and imports of finished products increase sharplyin the early 1980s as a result of forecast demand increases. In 1985, Mexicowould suffer a P 205 deficit in the form of finished fertilizers as well as phos-phoric acid. To meet this market need, Mexico plans to implement a newphosphoric acid plant as part of the Project and to exploit the recentlydiscovered domestic phosphate rock deposits in Baja California (para 2.09).For the longer run, FERTIMEX and the Government will have to decide if theyalso want to maintain the phosphoric acid exports for which markets have beensuccessfully developed by FFM with considerable effort in the recent past.In the event they should plan to export phosphoric acid beyond the early1980s, further phosphoric acid facilities will be required. The strategywill largely depend on how cost efficient the "second stage" of exploitationof phosphate deposits in Baja California will be, and the extent to whichspecifications in terms of P 0 concentration and chloride content will becomparable to competing Floridian or Moroccan rock.

F. Prior Bank Involvement

2.16 As mentioned, the proposed loan would be the second loan to FERTIMEXand also the second Bank operation in the fertilizer sector in Mexico. Thefirst loan of US$50 million was made in May 1975 (Report No. 734-ME, May 5,1975) for a nitrogen-based fertilizer project known as "GUANOMEX I" com-prising of two large-scale urea plants of 330,000 tpy and 495,000 tpy atSalamanca and Coatzacoalcos, respectively, and a small expansion by 3,300 tpyof an existing Parathion pesticide plant also located at Salamanca. All threeplants were originally scheduled for completion by October 1978, but seriousconstruction delays were encountered early in 1977 due to a shortage of localfunds arising from the Peso devaluation in September 1976, aggravated by thedislocation caused by major changes in the Company's management shortlythereafter. Furthermore, progress of the Salamanca projects after recommence-ment of work in June 1977 was extremely slow and culminated in termination ofthe main construction contract in March 1978. Since the appointment of a newcontractor in May 1978 and the strengthening of FERTIMEX' organization forconstruction management, the speed of the work has improved and completion ofthat portion of the project is now expected in July 1979, nine months behindappraisal estimates.

2.17 Construction of the 495,000 tpy urea plant at Coatzacoalcos was alsodelayed for similar reasons, but work on this project component is also nowproceeding satisfactorily and is expected to be completed by February 1980,some 14 months behind the original schedule. As a result of these delays, thePeso devaluation, and the resulting high local inflation, as well as the recentdepreciation of the value of the US dollar, installed project costs are nowestimated at US$155 million, about 35% higher than appraisal estimates. How-ever, because the international fertilizer prices now projected for the 1980s

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are (in constant terms) about 15% higher than originally estimated, 1/ the

project remains economically viable. After the difficulties encountered inearly 1977, the Government has continued to provide FERTIMEX with additionalfinancing needed to complete the project.

III. THE BORROWER AND PROJECT SPONSOR

3.01 As mentioned, the Project was prepared by and will be implementedand operated by FERTIMEX, the fully Government-owned national fertilizercompany formerly known as GUANOMEX (paras 2.01 and 2.05). FERTIMEX is alsoone of the major manufacturing companies in Mexico, with estimated 1978 salesof Mex$ 7.5 billion (US$330 million), including FFM operations. FERTIMEXwill be, along with Nacional Financiera (NAFINSA), the borrower of the pro-

posed Bank loan.

A. Organization and Structure

1. Corporate Charter and Organization

3.02 FERTIMEX is an autonomous public enterprise. Its shares are owned byNAFINSA, the Government's development bank and financial agent for publicsector enterprises. The Company is legally regulated by the Mexican CommercialCode and by its bylaws, as a private enterprise, but it is also expected to playa social and economic role. It is not only the country's main producer andsole distributor of fertilizer, but is also used by the Government as an im-portant instrument in the implementation of its agricultural sector policies.

3.03 Considering the importance of the Company to the national economy,the President of Mexico appoints the General Manager of FERTIMEX and themembers of the Board of Directors who have important positions in the Govern-ment. The Chairman of the Board is the Minister for National Patrimony andIndustrial Promotion (currently Mr. Jose Andres de Oteyza). Other members ofthe Board represent NAFINSA and other Government institutions such as CompaniaNacional de Subsistencias Populares (CONASUPO), and the Banco Nacional deCredito Rural (Banco Rural). The Ministries of Agriculture, Industry andTrade, and Finance are represented by their respective Secretaries. Managementis fully responsible for the day-to-day operations whereas policy decisions,especially concerning pricing, capital investments and long-term borrowing,are made by the Board of Directors in coordination with NAFINSA, the Ministryof Finance, the Ministry of National Patrimony and Industrial Promotion, andwith the Ministry of Programming and Budgeting.

3.04 The Organization Chart for the Company is shown in Chart C-1. Fivemajor departments report directly to the General Manager: (i) Operations,(ii) Sales, (iii) Administration, (iv) Planning and Development, and (v)Finance. The Operations Manager is responsible for the performance of all

1/ For 1985 the new equilibrium price is projected at US$175/ton of ureaFOB as compared to the earlier estimate of US$152/ton of ureain constant terms of 1978.

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plants at 10 different locations. As shown in para 2.13, FERTIMEX Opera-tions Department has a creditable record of running its facilities efficientlyat high utilization rates. The responsibility of the Sales Manager includesthe supervision of the sales agencies decentralized in eight sales regions(para 4.15 and Map IBRD 13550).

2. Planning and Construction

3.05 Planning and construction of new plants is the responsibility of thePlanning and Development Department. Feasibility studies and bidding documen-tation are prepared by its Planning Division, which normally carries the proj-ect responsibility until the contracts for engineering services are awarded,although staff from the Engineering and Construction Division is also involvedin the technical evaluation of the bids. After the engineering firms arechosen, the Engineering and Construction Division takes over full projectsupervision responsibility during the implementation phase. This shift inresponsibility has not caused any major problems, due to the close coordina-tion between the two divisions. During the recent past, this Department hasstrengthened its staff (in part by seeking assistance of independent consul-tants) and broadened its construction management capabilities, in order torectify past weaknesses in construction planning and site work schedulingfunctions. In the future, the Department will be capable of more extensivesupervision of contractor's construction scheduling and work programming, toavoid delays in construction from which earlier projects have suffered (para2.16). Furthermore, a subdivision for planning and information has beenformed which is currently introducing a capital works cost coding systemallowing comparison of progress commitments with allocated project budgets.This subdivision will also be in charge of regular preparation of monthlyprogress reports for the management, which so far has not proven satisfactoryas a management tool. A detailed organization chart of the Planning andDevelopment Department is given in Chart C-2.

3. Financial

3.06 During project appraisal, the Finance Department also underwentconsiderable reorganization, which has resulted in an improvement in itsoperations although it is too early to judge the effectiveness of thenew control systems, some of which are not yet operational. Chart C-3 givesthe most recent organogram of the Finance Department. Four divisions reportto the Financial Manager: (i) Financial Accounting, (ii) Treasury, (iii)Management of Accounts Receivable, and (iv) Financial Planning. The restruc-turing of the Finance Department was undertaken to: (a) improve financialreporting system needed by the management to take corrective steps at an earlystage and (b) implement a long-term financial planning system allowing manage-ment to develop a financial strategy and detailed measures necessary to meettarget financial performance criteria.

3.07 Substantial progress has been made in the recent past in financialreporting. FERTIMEX now prepares a monthly financial report with an adequatesection on financial ratios and graphical recording of trends in key financialdata, thus providing management with a better tool for decision making.

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However, timely availability and accuracy of the reports, which are at presentprepared manually, still need improvements. To this end, FERTIMEX is pre-sently introducing an integrated information system utilizing electronic dataprocessing equipment. It is expected that the first stage of this system -which will integrate data from each plant, sales agency and warehouse - willbecome fully operational in mid-1979. However, in addition, the Company stillneeds to develop an appropriate financial planning and control system morein accord with the size and complexity of its operations. It has alreadyreceived offers for assistance in developing such a system from severalconsulting firms which are presently being evaluated. FERTIMEX plans tocontinue to carry out improvements in its financial planning and controlsystem and employ outside experts for this purpose, if necessary. It willsemiannually consult with the Bank on the progress made in the area; firstsuch consultation will take place before December 31, 1979.

B. Manufacturing Facilities

3.08 FERTIMEX currently owns fertilizer production facilities at tenlocations in Mexico (MAP IBRD-13550). The table in Annex 3-1 showsthe manufacturing capacities and past production output of each of theseplants as well as the capacities of new plants under construction or planned.The existing fertilizer capacities total about 2.1 million product tons peryear, equivalent to about 430,000 tpy of N and about 260,000 tpy of P 205 . Asmentioned, FERTIMEX' production capacity utilization has been good for most 6fthe plants in the recent past.

3.09 In addition to the proposed Project, FERTIMEX presently has amajor expansion program under implementation which was originally estimatedto cost about Mex$ 5,300 million (US$235 million equivalent). Of this, the"GUANOMEX I" Urea Project being financed by the Bank (para 2.16) accounts forabout 55%, another export-oriented urea project at Pajaritos for about 25% anda single superphosphate plant for 10%. The remaining 10% of the estimatedinvestment costs are spread over several smaller rationalization/expansion andpollution control projects.

3.10 The expansion program of new plants, including the Project, cur-rently scheduled for completion by end-1982, is expected to increase FERTIMEX'production capacity for ammonium sulfate by about 30%; ammonium nitrate by100%, urea by 300%, DAP by 200%, SSP by 100% and NPK by 200%. In terms ofnutrient content, FERTIMEX will have nearly tripled its N and about doubledits P205 production capacity after completion of this expansion program.However, FERTIMEX is planning to shut down its obsolete production facilitieswith total production capacities of 87,000 tpy urea, 225,000 tpy ammoniumsulfate and 180,000 tpy SSP. FERTIMEX management is considered capable ofsatisfactorily implementing this large construction program, which is notexpected to adversely affect the implementation and financing of the Project.

C. Financial Situation

3.11 FERTIMEX' financial statements for the period 1974-77 are shownin Annex 3-2 and summarized below:

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FERTIMEX - Summary Financial Statements d/(in million of Mex$)

1974/75 - 1975/76 - / 1976-' 1977 1978…------- Actual ------ Prelim.

Income StatementRevenues from Net Sales 3,205 4,285 1,702 6,019 6,366

Compensatory Payment on Sales 665 235 - 1,465 1,489

Total Revenues 3,870 4,520 1,702 7,484 7,855

Cost of Goods Sold 3,199 3,954 1,512 5,890 5,973Depreciation of Revalued Assets - - - 225 966

Gross Profit/(Loss) 264 141 (139) 878 882

Financial Expenses 193 145 826-S/ 1,032-s/ 712-i/Reimbursements on Exchange Losses - - 681 572 103

Net Income 62 (112) (275) (100) 6

Balance SheetCurrent Assets 2,991 3,901 4,737 5,875 6,147

Current Liabilities 2,747 3,373 5,725 4,556 5,942Long-Term Rec./Investments 429 411 1,786 2,559 2,803

Fixed Assets (Net) 972 1,416 2,496 4,236 5,769

Long-Term Loans 490 1,023 1,567 4,426 4,307Deferred Credits - - 691 933 781

Equity 1,218 1,384 1,093 2,832 4,073

Total Assets and Liabilities 4,455 5,780 9,076 12,747 15,103

RatiosCurrent Ratio 1.1 1.2 0.8 1.3 1.0Long-Term Debt/Equity Ratio 29/71 42/58 59/41 65/35 56/44

Debt Service Coverage 1.5 0.7 -1.5 0.5 1.1Return on Total Assets (%) 1.4 (1.9) (n.a.) (0.7) -Net Income/Total Revenues (%) 1.6 (2.5) (16.2) (1.3) -Exchange Rates: Mex$/US$ 12.5 12.5 20.0 22.5 22.5

a/ Fiscal year ended June 30.b/ Fiscal year changed to calendar year; relates to period July-December 31.

c/ Including foreign exchange losses.d/ Without consolidation with FFM.

3.12 FERTIMEX' financial situation has recently deteriorated as indicated

by its tight liquidity position, declining financial ratios and its difficulty

to service debt from internal cash generation. The Company would have made

substantial losses every year but for the compensatory payments by the Govern-

ment as shown in the above table and described below. FERTIMEX' financial

difficulties are largely outside the Company's control and are primarily due

to the Government's fertilizer pricing policies and the 1976 devaluation of

the Peso (paras 3.14 and 3.16).

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3.13 The financial performance was also hampered partly by the Companv'sinadequate management and control of working capital. FERTI[EX has requiredhigh levels of working capital due to exceptionally high inventories aridaccounts receivable (equivalent to about 7 and 4 months of sales, respectively,in 1978), which though partly offset by high accounts payable (5.5 months ofsales in 1978) still required working capital equivalent to about 5.5 morLthsof sales to be financed via short-term loans. These loans in turn increasedinterest charges and thus adversely affected cash flow and profitability.Inventory and accounts receivable are planned to decrease to more reasonablelevels, reducing working capital requirements to about 3.5 months of saletsby 1981. In any case, the Company's maanagement needs to regularly monitor itsworking capital situation. Moreover, to resolve the long-term liquidityproblem, FERTIMEX should finance its permanent working capital through long-term sources to improve the current ratio above the present 1:1; in fact,conversion of short-term loans of about Mex$ 1,200 million into long-termloans would improve the current ratio to 1.3:1, the level stipulated in the"GUANOMEX I" Loan Agreement. FERTIMEX has undertaken to reduce its workingcapital requirements to an equivalent of 3.5 months of its correspondingannual sales revenues and to reduce it:s short-term loans. Ihe Government: hasagreed to assist FERTINEX in this effort.

3.14 Besides carrying the overall responsibility of Mexico's fertil:izersupply, FERTINEX performs other specific tasks 1/ for which it has not beenadequately compensated. Following the 1976 Peso devaluation, FERTIMEXhas also suffered heavy exchange losses on foreign loans contracted by it inaccordance with government policies to relieve the local capital markets (95%of FERTIMEX' outstanding short- and long-term loans are denominated in foreigncurrencies). FERTIMEX has also been unable to recover throtgh retail salesprices, fixed by the Government, the cost of higher priced imported rawmaterials and finished fertilizers. To avoid an accumulation of losses, theGovernment agreed in 1974 to compensate the Company for the differentialbetween higher import price and lower domestic manufacturing cost and tooffset the foreign exchange losses andl the 200% increase in the ammonia priceintroduced by PEMEX early 1977. In spite of these compensatory payments,FERTIMEX' financial performance had been deteriorating through 1976.

3.15 Although in October 1976 and January 1977 the Government approvedfertilizer price increases of 10% and 25%, respectively, thes Company stillrequired various types of compensatory payments (against losses on sale ofimported products, ammonia price increases by PEMEX, and foreign exchangelosses) totalling about Mex$ 2,040 million in 1977. During the period 1974-77,the compensatory payments aggregated some Mex$ 3,600 million or 21% of salesrevenues. For 1978 and 1979, the Government approved further price increasesof 15% and 16%, respectively, about equal to the prevailing inflation rates.However, the new fertilizer prices did not increase ex-factory revenues to thefull extent since FERTIMEX has been asked by the Government to offer farm-ers about 16% discount on the new retail prices. The Government indemnifies

1/ FERTIMEX (i) coordinates the country's production plans for fertilizer;(ii) arranges necessary imports for finished fertilizer as well as rawmaterials and intermediate products; (iii) acts as a holding company forother Government-related and often loss-making enterprises; and (iv) actsas financing agent for fertilizer customers (mainly other governmentagencies).

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FERTIMEX for the lost revenues due to the discount through a special compen-sation. For 1978, FERTIMEX estimates total compensatory payments of aboutMex$ 1,600 million (US$71 million equivalent), equal to 20% of its totalrevenues. Despite these large payments the Company achieved in 1978 onlya marginal net income of about Mex$ 5.7 million (US$250,000) equivalent toless than 0.01% return on assets, primarily due to the low retail fertilizerprices.

3.16 In mid-1978, international prices (CIF Mexico) of the productsmanufactured by FERTIMEX were on average about 35% above the Company's salesprices. Had FERTIMEX been allowed to charge international prices for itsproducts, the profit of Mex$ 5.7 million estimated for 1978 would have in-creased to Mex$ 1,175 million, equivalent to a 10% return on assets. Animprovement of FERTIMEX' revenues is also essential to bring its debt-ser-vice-coverage ratio to the minimum level of 1.4, specified in the "GUANOMEX I"Loan Agreement. As further discussed in paras 4.29-4.30, agreement has beenobtained from the Government on the introduction of a pricing policy which willallow FERTIMEX to meet its financial obligations and earn an adequate returnon assets at efficient operations. Such a pricing policy would make FERTIMEXfinancially viable and permit it adequate autonomy to administer its ownaffairs.

D. Acquisition of Fertilizantes Fosfatados Mexicanos (FFM)

3.17 FFM's financial performance had also been unsatisfactory (ProjectFile - Reference D). In 1975 and 1976, the Company sustained losses of aboutMex$ 190 million and Mex$ 270 million, respectively, and at the end of 1976accumulated losses carried forward amounted to Mex$ 380 million or 86% ofFFM's share capital. The main reasons for FFM's poor financial performancewere: (i) a decline of sales revenue in 1975-76, due to a reduced volume ofproduction coupled with a substantial (temporary) drop in internationalphosphoric acid prices; (ii) minimal corresponding savings in cost of goodssold despite declining phosphate rock prices, due to rising costs of laborand other inputs as a result of the 1976 devaluation of the Peso; (iii) heavyinterest expenses caused by increasing recourse to short-term loans; (iv) ap-parent production shortfalls, which forced the Company to purchase phosphoricacid abroad in order to fulfill supply contracts; and (v) losses arising fromsubsidiaries and other extraordinary ventures abroad.

3.18 With the appointment of the former GUANOMEX General Manager asPresident of FFM in mid-1976, and with improved operating efficiency, FFM hadovercome its major difficulties as reflected by the considerably reduced lossesin 1978 and an expected the break-even performance for 1979 (Project File -Reference D). This consolidation of GUANOMEX and FFM top managements wasplanned to prepare for the subsequent merger of both companies, and appearsto have worked well. From the operational point of view, the merger becameeffective on January 1, 1978, when the FFM plant was assigned as part ofFERTIMEX' production facilities and managerial functions, like policy plan-ning, production, distribution and administration, 1/ were fully integrated

1/ Some of FFM's administrative staff was absorbed by FERTIMEX as far asjustifiable by its overall staffing plan -- while the rest was hiredby other government agencies.

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into FERTIMEX. The operational and administrative integration of FERTIMEXand FFM organizations and personnel into a single entity has not caused anymajor difficulties. In legal terms, however, the acquisition of FFM has notyet been fully consummated.

3.19 While in principle it has been agreed that FERTIMEX is the acquir-ing company, the exact legal procedures and financial terms have not beencompletely determined. Nevertheless, the basic plan is that FERTIMEX willacquire FFM's major assets 1/ and liabilities of domestic operations. Thefixed assets will be valued at their replacement costs which are expectedto be about four times their current book value. This revaluation of FFMassets will not only partly compensate for FFM's accumulated losses, but willalso strengthen FERTIMEX' equity position. The Company expects a modestprofit contribution from the former FFM operation to its overall results in1979. Finally, there is a good potential for further improvements in thefuture through the conversion of a part of FFM's TSP capacities to DAP pro-duction; this would involve only relatively minor capital expenditures. Thenew DAP production could substitute for imports. Therefore, overall, theacquisition of FFM into FERTIMEX is expected to have a positive impact on theCompany's financial structure and performance, provided the final terms aresimilar to those currently contemplated. The Government and FERTIMEX areexpected to consummate the merger under terms which will not adversely affectFERTIMEX' financial structure and performance.

IV. THE MARKET AND MARKETING SYSTEM

A. Agriculture in Mexico

4.01 Mexico had an estimated population of about 64 million in 1977.The population has been growing at an annual rate of 3.5% and is projectedto reach about 84 million by 1985. While no detailed labor statisticsare available, between eight and twelve million people are estimated to beemployed in agriculture, providing a living for some 29 million people, about37% of Mexico's population. Despite the large percentage of the populationdependent on agriculture, the sector contributed only 10% to GDP in 1977,compared to 16% in 1976 due to a much slower growth in the agricultural sec-tor compared to the high growth rate of the overall economy (para 4.04).Agricultural exports totalled US$1.2 billion in 1976 but, due to shortfallsin some areas of food production, Mexico imported maize, wheat and otheragricultural products totalling US$360 million.

4.02 Mexico has an area of about 2 million square km (or 200 millionha). Land distribution in Mexico as reported in 1977 is shown below:

1/ Consisting of FFM's domestic plant and distribution facilities (exportstorage, equipment for product handling at the pier and cargo ships)and the related working capital.

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Mexico - Land Distribution in 1977(in million ha)

Area Suitable for Cultivation 32 16%

Area in Pastures and Meadows 74 37%

Forest Area 20 10%

Balance 74 37%

Total Land Area 200 100%

While 32 million ha or 16% of the total land area are suitable for culti-

vation, the area actually cultivated is less than half this size. Despite

Mexico's efforts to bring new land into cultivation and expand the area

under irrigation, the total area under cultivation has only increased mar-

ginally, from 15.0 million ha in 1970 to 15.5 million ha in 1977. The break-

down between irrigated and non-irrigated land is shown below:

Mexico - Irrigated and Non-Irrigated Area under Cultivation in 1977(in '000 ha)

Fertilized as

Cultivated Fertilized a/ % of Cultivated

Irrigated 4,500 4,000 88

Non-lrrigated 11,000 3,500 32Total 15,500 7,500 48%

a/ Forms part of cultivated area.

The above table indicates the large discrepancy of fertilized land between

irrigated and non-irrigated areas. While nearly the entire irrigated area

is fertilized, only about one-third of the non-irrigated land uses fertilizers

due to the unreliability of rainfall in parts of the non-irrigated areas.

4.03 The detailed crop pattern by region is shown in Annex 4-1. The

five major crops, which are corn, beans, sorghum, wheat and sugarcane, are

grown on about 70% of the total land under cultivation. The table below

gives the area under cultivation for each of these five crops in relation

to the total cultivated area in the country.

Mexico - Area under Cultivation for Five Major Crops: 1974-76(in '000 ha)

1974 1975 1976

Corn 6,717 6,694 6,782

Beans 1,552 1,753 1,315

Sorghum 1,156 1,445 1,252

Wheat 774 778 893

Sugarcane 492 476 496

Total Area for 5 Crops 10,691 11,146 10,738

Total Cultivated Area 15,867 15,484 14,777

Over the past 14 years, improved cultivation practices, increased irrigation,

better seeds, and use of fertilizer have raised average yields in Mexico as

indicated in the following table:

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Mexico - Average Yield of Five Selected Crops: 1962-1976(in kg/ha)

Percent Increase1962 1972 1976 1972/62 1976/62 1976/72

Corn 1,015 1,148 1,225 13 21 7

Beans 504 524 639 4 27 22

Sorghum 2,072 2,118 2,908 2 41 37

Wheat 1,462 2,721 2,245 86 50 (17)

Cotton 633 822 856 30 36 4

4.04 Despite these improvements, the growth of total agricultural crop

production has been only 1.1% per annum during 1965-76, well below the demo-

graphic growth rate of 3.5%. This low increase in crop output is particularly

disappointing when compared with the average 6% annual rate of growth experi-

enced during 1945-65; it is mainly the result of the increasing physical com-

plexity and higher costs of large-scale irrigation schemes and the lack of

alternative agricultural strategies, as well as the uneasiness felt by many

land owners regarding the security of their land titles. This near stagnation

of crop production combined with lack of positive support for farming in rain-

fed areas has resulted in a decline of average annual income of farm workers.

The Government is becoming increasingly aware that, by over-emphasizing large

scale irrigation schemes in the past to the detriment of extension work in

rainfed areas the full production potential of about two-thirds of Mexico's

cultivated area has not been fully exploited, and that the income disparity

between the modern and traditional sector has been seriously aggravated.

4.05 By the mid-1970s, therefore, several programs had been initiated

to provide improved extension assistance to rainfed crop farmers and complete

development packages to low-income farmers in selected areas. As experience

with these programs is comparatively short, further time must elapse before

their results can be ascertained. Although their main thrust is correct

and prospects for increased output of rainfed agriculture appear promising,

major efforts in trained manpower mobilization and research, as well as capi-

tal investments in infrastructure, will be needed. The Government has also

taken measures to improve the availability of credit to farmers, including

consolidation of its agricultural credit programs under the National Bank

of Rural Credit. The agricultural pricing policy is to set prices at levels

necessary to encourage production arid bring about desired cropping pattern

changes. These measures and efforts to improve timely availability of agri-

cultural inputs such as fertilizers at reasonable prices, are expected to

help achieve increased yields per hectare and thus improve the productivity

of the sector. A more detailed review of the issues and development pros-

pects in the agricultural sector is given in the chapter on agriculture of

the Basic Economic Report on Mexico, currently being prepared by the Bank.

B. Fertilizer Use in Agriculture

4.06 Past fertilizer consumption in Mexico is given in Annex 4-2.

During the 1960-78 period, nitrogen (N) consumption increased at an average

annual growth rate of 14%, phosphate (P20 ) at 15%, and potash (K20) at 13%.

Total fertilizer consumption dipped slightly in 1976 due t:o a 4% and 15% drop

in nitrogen and phosphate consumption, respectively, but after reaching the

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previous level again in 1977 all three nutrients resumed their former growthtrend in 1978. The lower than expected estimated fertilizer consumption in1976 and 1977 was brought by three factors: (i) a total price increase ofabout 35% at retail level during late 1976 and early 1977, without corre-sponding changes in crop prices; (ii) adverse weather conditions in certainparts of the country, and (iii) unstable economic conditions. Despite thepast healthy growth rate in fertilizer consumption, fertilizer usage remainslow at 34 kg/ha of arable land. FAO statistics for 1977 nutrient consumptionper ha of arable land in some other countries are: USA (92); Brazil (49);Spain (69); Romania (114); Portugal (67); and India (17).

4.07 In the recent past, the N to P 0 fertilizer application ratio inMexico has varied substantially between i Po 1 and 2.5 to 1, primarily as aresult of availability of supply (para 4.14), but has moved in the rightdirection toward a higher proportion of P20 On a regional basis the appli-cation ratio has varied even more widely. kor example, in 1976, the westernregion had an N/P 05 ratio of 9.3 to 1 while the southern region had one of1.7 to 1. Estimates indicate that the optimal ratio for Mexico would bearound 2.8 to 1, although the ratio will need to vary with regions and crops.

4.08 It is estimated (Annex 4-3) that the five major crops (corn, beans,sorghum, wheat and sugarcane) account for about 70% of the total fertilizerconsumption, although corn and beans, the two main crops for domestic con-sumption (which occupy 55% of the total cultivated area), have not partici-pated in fertilizer use to the extent of other crops. Corn and beans aremainly grown in non-irrigated areas where rainfall is unreliable. Therefore,concurrently with improved fertilizer supply, supplementary irrigation hasto be promoted if fertilizer consumption is to be effectively increased.However, considering that over 70% of cultivated area is non-irrigated andthat this is also the area most inadequately fertilized (para 4.02), the majorpotential for increased fertilizer use in the future lies in the non-irrigatedareas. To exploit the best potential of this area, promotional efforts shouldat the beginning be concentrated on non-irrigated areas with better rainfallreliability and better soil depths for storage of moisture; these areas areestimated to comprise about 20% of the land under cultivation. At the sametime, greater efforts need to be made to promote increased fertilizer use inthe rainfed areas, particularly by small farmers who currently use limitedamounts of fertilizer. As mentioned, the Government has already redirectedits agricultural strategy to better improve the productivity of rainfed areasand assist small farmers, and is implementing positive policy measures con-cerning agriculture extension services, credit and pricing (paras 4.04-4.05).Considering these measures and that currently only about half of Mexico'scultivated land receives fertilizer, some of it at relatively low rates,the opportunity for increasing fertilizer consumption is good. However,recent Government measures must be supported by increased efforts of promotingfertilizer use in these target areas and by timely provision of the most suit-able products. Assurances have been obtained that the Government will: (a)continue to carry out adequate extension and seeding programs aimed at expand-ing fertilizer use; and (b) focus on the particular promotion of NPK and DAPfertilizers, which are relatively new to the farmers and are more suitable forrainfed agriculture.

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C. Historical Fertilizer Demand and Supply Balance

4.09 Historical fertilizer consumption, production and trade balanceare given in the table below:

Mexico - Historical Fertilizer Consumption, Production and Trade Balance(in '000 tons of nutrient)

a! b/ CotshNitrogen-/ _ Phosphate- Potash_/_

Cons. Prod. Imp. EX. Cons. Prod. I Exp. Cons.

1950 8 - 8 - 2 2 - - -1960 98 19 79 - 25 15 10 - 71963 196 163 33 - 64 53 11 - 201973 561 454 256 37 179 382 2 228 391974 593 445 246 15 235 406 3 182 341975 722 675 210 28 276 392 19 135 551976 830 773 281 15 234 374 14 141 611977 795 838 186 33 217 414 11 208 581978 (Est.) 992 1,554 215 575 286 415 34 163 66

Annual Growth Rates (%)

1950-60 28.5 4.9 - - 28.7 22.3 - - n.a.1960-73 14.4 27.7 - - 16.4 28.3 - - 14.11973-78 12.1 27.9 - - 9.8 1.7 - - 11.11960-78 13.7 27.7 - - 14.5 20.3 - - 13.3

a/ The portion of available N nutrient exceeding the N consumption forfertilizer reflects the ammonia used for industrial purposes, whichcurrently varies between 15% and 20% of the total domestic N demand.

b/ Including phosphoric acid.c/ All potash requirements are imported.

4.10 Nitrogen is Mexico's most important fertilizer nutrient, account-ing for about three-fourths of total fertilizer consumption. Nitrogen produc-tion rose from 163,000 tpy of nutrient in 1963 to an estimated 1.5 milliontpy in 1978, equivalent to an average annual growth rate of 16%. While thisgrowth rate exceeded that of domestic consumption, most of the increased pro-duction was for ammonia, and Mexico continues to import increasing quantitiesof finished nitrogenous fertilizer. With regard to phosphatic fertilizersthere is also an itabalance between domestic consumption and production whichhas resulted in exports of some products and imports of others. Mexico hasbeen exporting phosphoric acid and TSP but, again due to insufficient facil-ities to convert intermediates into fertilizer end-products, there is pres-ently a shortage of diammonium phosphate (DAP) and complex fertilizers whichneeds to be covered by imports. The following table shows Mexico's recentexport/import balance for fertilizers, broken down by product:

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Mexico - Export/Import Balance of Nitrogenous and

Phosphatic Fertilizers - 1976/77(in '000 tons)

1976 1977

Imports Product N P2 05 Product N P2 05

Ammonium sulfate 345 71 - 298 61 -

Ammonium nitrate 105 37 - 78 27 -

Urea 229 106 - 82 38 -

NPK/DAP 83 12 14 43 7 11

Ammonia 67 55 - 64 53 -

Total Imports 829 281 14 565 186 11

ExportsPhosphoric acid 203 - 110 246 - 133

Ammonia 18 15 - 40 33 -

TSP 63 - 30 156 - 75

Total Exports 284 15 140 442 33 208

D. Projected Demand and Production of Fertilizers

4.11 The projected domestic demand and production of fertilizers with

and without the Project, are summarized in the table below:

Mexico - Projected Domestic Demand and Production Fertilizers(in '000 tons of nutrient)

Nitrogen Phosphates Potash

Ta/ Finished

Total Nitrogen- Fertilizers b/

Production Production Production-

With- With- With- Demand

out With out With out With Equiva-

Proj- Proj- Proj- Proj- b/ Proj- Proj- lent to

Demand ect ect Demand ect ect Demand- ect ect Imports

197 7(act.) 795 838 838 609 423 423 217 414 414 58

1978(est.) 992 1,554 1,554 776 421 421 286 415 415 66

198(0 1,137 2,259 2,259 900 750 750 341 460 460 80

1982 1,316 3,025 3,025 1,059 785 870 403 465 540 100

1985 1,680 3,209 3,209 1,395 990 1,150 521 465 565 135

Annual Growth Rates (%)

1960-78 13.7 27.7 27.7 n.a. n.a. n.a. 14.5 20.3 20.3 14.1

1978-85 7.8 10.9 10.9 8.7 13.0 15.4 13.3 4.5 1.7 .8

a/ Including ammonia not converted into finished fertilizer.

b/ Including phosphoric acid.

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The above projections were prepared by FERTIMEX (Project File - Reference A)

using trend analysis on the basis of the sum of adjusted l:Lnear projections

of consumption for individual fertilizer products covering the period 1950

through 1977. A secornd fertilizer demand forecast, prepared by the Ban'k

consultant from the International Fertilizer Development Center, Muscle

Shoals, Alabama (IFDC), using straight line and exponentia'L curves for trend

analysis (Project File - Reference B) gives overall nutrient demand figures

close to (though marginally below) the FERTIMEX forecast (Chart C-4). But

the IFDC analysis also indicates that, while dividing the overall nutrient

demand amongst various finished fertilizers, FERTIMEX has most likely under-

estimated demand for the higher analysis fertilizer to be produced under the

Project, as discussed below in para 4.14. Both projections, however, confirm

that without the Project Mexico would become a net importer of phosphatic

fertilizers in the mid-1980s.

4.12 In this report FERTIMEX' projections are used since the forecast

growth rates of 8% and 13% for N and P 05, respectively, appear to be real-

istic compared to the 14% and 15% grow h rates recorded in the past 20 years

and considering the large potential for increased fertilizer consumption and

the measures being taken by the Government to increase agricultural produc-

tion (para 4.08). This approach also gives a more conservative demand/sup-

ply balance for the Project's finished products output than the consultant's

findings.

4.13 Domestic demand and production forecasts (inclusive of the Project)

for the three finished fertilizers to be manufactured by the Project are given

below:

Mexico - Projected Demand and Production of AN, DAP and NPK(in '000 tons of nutrient)

Average Growth1978 1980 1982 1985 Rate 1978-85

(%)AN (nitrogen)Capacity a/ 60 60 130 130 12

Production 60 60 110 130 12

Demand 85 90 100 110 4

Surplus (Deficit) b/ (25) (30) 10 20

DAP (P205)

Capacity a/ 60 60 180 180 17

Production 60 60 150 180 17Demand 85 100 110 135 7'

Surplus (Deficit) bj (25) (40) 40 45

NPK (P 205 )

Capacity a/ 30 30 85 85 16

Production 30 30 65 85 16Demand 45 55 65 85 SI

Surplus (Deficit) bt (15) (25) - -

a/ DAP and NPK capacities are based on 300 operating days/year

and AN on 330 operating days (para 5.01).b/ In domestic production.

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4.14 The estimated production matches approximately the projected demand

for AN and NPK, whereas DAP production exceeds the demand forecasts by about40,000 tpy of nutrient during the period immediately after Project start-up.However, the Bank consultant's analysis (Project File - Reference B) con-cludes that the above FERTIMEX projections of demand for these high analysisfertilizers are conservative for three reasons. First, FERTIMEX projectionsof future demand are based on a linear projection of past trends. However,the past consumption statistics for DAP-/NPK-type fertilizers do not reflecttheir current potential demand since the products have not been availablefor sale in adequate quantities. Shortages of various types of fertilizershave occurred regularly in the past and farmers had to use whatever type ofnitrogen or phosphate product was available. Hence, past restricted consump-tion has affected trend projections for all solid nitrogen products, highanalysis phosphates, and compound fertilizer. Secondly, statistics reportedby FERTIMEX do not take into account sizeable tonnages of physical bulk blendsthat are being produced by FERTIMEX' agents (para 4.16). Therefore, the pastdata underestimates the actual consumption of these products. Thirdly,recently increased supplies of urea, TSP, and DAP have resulted in expandedfarmer acceptance for these higher analysis fertilizers and consequently havecaused a sharp increase in demand during the past few years. For example,FERTIMEX imported over 100,000 tons of DAP in 1978. With a continuedprogram of importing DAP prior to the start of the Project (para 4.08),domestic demand should be sufficiently strong in 1982 to allow full utiliza-tion of the country's planned DAP production capacities. Given the conserva-tive nature of the demand projections, and considering the likely positiveeffects of the recommended seeding program, domestic demand is expected to besufficient to absorb the Project's entire output.

E. Fertilizer Marketing and Distribution

1. Project Marketing Area

4.15 The marketing area designated by FERTIMEX for the Project consistsof 14 states in Bajio, Northeast, Northwest and the West as shown in MapIBRD-13550. In 1976, this marketing area represented 59% of total nitrogenand 46% of total phosphate consumption in the country. It is estimated thatby 1982 this market area would consume about 710,000 tpy of nitrogen (58% ofcountry total) and 190,000 tpy of phosphate (47% of total). Considering thatthe Project's total nitrogenous fertilizer production capacity (158,000 tpy)is equivalent to only 22% of total regional demand, the Project output couldbe fully absorbed within the area. However, considering that the Project'sphosphate fertilizer capacity of 181,000 tpy is 97% of projected 1982 regionaldemand and that a new SSP plant with a capacity of 60,000 tpy of P 20 is alsobeing planned for the area, FERTIMEX would need to distribute for a few yearspart of this SSP production or of the Project's output in other parts ofMexico. Considering, therefore, the overall market prospects in the country,no major difficulty is expected in marketing the Project's output.

2. Distribution System

4.16 As explained in para 2.05, FERTIMEX is the only agency for thewholesale distribution of fertilizers, including ammonia for direct appli-cation. The fertilizer distribution system is shown on the following page.As a matter of policy, FERTIMEX has avoided being tied to only one channelof distribution. In 1977, the Company sold about 42% of the fertilizer

FERTIIMEXS - LAZARO CARDENAS

FERTILIZER PROJECT

SSOLURCEs OF RAw MATERIALS AND DISTRIBUTION CANL

M Ports Of oa;

PEME |

One-SteSp Systemm

42% arketi,

p

Finished Ferti2er

|~~~~0

lWarehOus

n

090at Twos r,ySep systemn

CommssiO0 Agents46Wrhousing, Bagging

- 24 -

directly, and the remaining 58% indirectly with the assistance of four other

organizations under a two-step distribution system. FERTIMEX' direct sales

are either made to large farmers and industrial users, or through some 200

commission agents, 95% of whom are private. The commission agents not only

act as sales agents, but also provide storage and handling facilities.

They warehouse the fertilizer, bag bulk shipments, and make sales in FERTIMEX'

name. A number of commission agents are also involved in bulk blending

for their own accounts, and sell this product under private labels to farmers

and farmer organizations.

4.17 The second distribution system, the indirect two-step operation

which is becoming increasingly important, consists of sales by FERTIMEX to

Banco Nacional de Credito Rural (BANCRURAL), sugar companies, "organiza-

ciones agricolas" (agricultural organizations) and CONASUPO (Government-

owned retail store organization). These entities buy products from FERTIMEX

either shipped directly from FERTIMEX plants or through the commission agents

or service agents (Prestador de Servicios). The latter provide warehousing

and trucking on a contractual basis with FERTIMEX. Although this distribution

system has met FERTIMEX' needs in the past, it is not adequate to reach an

increasing number of small farmers necessary to meet the projected fertilizer

consumption growth targets. FERTIMEX particularly needs to increase the

number of dealers located close to small farmers. It may also have to con-

sider a gradual move to a three-step distribution system, involving private

wholesalers and independent dealers, as is common in other countries (para

4.22).

3. Product Handling and Commissions

4.18 Product handling allowances currently paid by FERTIMEX to its

agents hardly cover costs. In addition, sales commissions are extremely low

and run from 2.4% on potassium sulfate to 5.5% on ammonium sulfate. These

low commissions and absence of a three-step distribution system mentioned

above, do not allow small private dealers to participate in sales of ferti-

lizer in Mexico. As a result, small farmers needing only one or two bags of

fertilizer at a time often must travel a long distance to reach one of the

authorized distribution organization warehouses (which are located close to

railheads) or a retail CONASUPO store. Therefore, the present system does

not effectively serve the small farmers.

4.19 Approximately 70% to 80% of the fertilizer shipped from FERTIMEX

factories is in bulk form. Bulk material is sent on consignment to commis-

sion agents and service agents who perform the bagging service. Commission

agents may purchase a part of the tonnage shipped to them for resale to farm-

ers in the area. Service agents have no resale rights. Material in service

agents' warehouses is designated for reshipment to other authorized organiza-

tions in the distribution channels. Fertilizer awaiting reshipment in com-

mission agents' and service agents' warehouses is stored at FERTIMEX' ex-

pense. Warehousing fees paid to commission agents are on average Mex$ 3 per

ton per month and Mex$ 5 per ton per month for service agents, which again

are inadequate (para 4.22).

4. Warehousing and Inventories

4.20 Fertilizer is warehoused by each of the agencies involved in fer-

tilizer distribution and by FERTIMEX at its plants; anhydrous ammonia in

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storage tanks at terminals mostly owned by PEMEX. Annex 4-4 summarizesinformation on warehouses for four of the seven distribution channels. Thetotal estimated storage capacity of solid material and ammonia is 1,591,000tons, equivalent to about 55% of the total product tonnage sold in 1977;the distribution of this warehousing capacity is shown below:

Mexico - Fertilizer Storage Capacity for Solid Fertilizer and Ammonia(in '000 tons)

Owner Number of Warehouses Storage Capacity

Commission Agents 514 759CONASUPO 420 609Service Agents 44 169FERTIMEX 30 55

1,008 1,592

While a major increase in storage capacity is not immediately needed tosupport the sales in the Project's marketing area, FERTIMEX or other chan-nels of distribution may need additional small warehouses away from rail-heads to better reach small farmers.

4.21 FERTIMEX' total inventories represented about 42% of sales in1975, 51% in 1976, 1/ 46% in 1977, and 58% in 1978. After adjustments for rawmaterial inventories, average fertilizer product inventories constituted about5.5 months of sales which on all accounts is unduly long. Field informationindicates that it takes between 50-90 days from the date of placing an orderwith FERTIMEX' order processing department before products arrive in thefield warehouse. With such long order processing delays, regional managersbuild stocks in their warehouses months in advance of anticipated sales dates.In theory, product held on consignment by one commission agent could betransferred to another who is in short supply. However, in practice, lessthan 1% of inventories is transferred to other points of storage. Productshortages of AN, compound fertilizer, urea, and DAP, are commonplace andtherefore, agents with stocks of these materials are reluctant to releasethem to others. On some occasions, fertilizers have been in storage for aslong as two years and have become unuseable.

4.22 FERTIMEX' current distribution system thus has certain shortcomingsand inefficiencies. Therefore, the present system should be reviewed cri-tically by FERTIMEX to identify improvements necessary for meeting futurefertilizer marketing needs more effectively and at lower cost. A more specificevaluation of FERTIMEX' distribution system would complement the earlier study 2/concerning market and marketing aspects of fertilizer in more general termsrequested in the existing loan agreement and submitted to the Bank in July1976. FERTIMEX has agreed to prepare by August 31, 1980 a study of the cur-rent distribution system as well as its related costs and shortcomings andthe steps that are needed to improve the system in accordances with draft

1/ Until 1976, FERTIMEX' fiscal year ended June 30 near thie end of peakfertilizer sales for a given year and should therefore put inventoriesat their lowest point.

2/ Analisis de los Factores que Determinan la Demanda de Fertilizantes.

- 26 -

terms of reference shown in Annex 4-5. FERTIMEX would, on a regular basis,keep the Bank informed about the progress of the study and take prompt actionsafter its completion to implement its recommendations.

5. Transport

4.23 As part of Government policy, fertilizer plants in Mexico are dis-persed throughout the country as shown on Map IBRD-13550. In 1976, railmovement of raw and intermediate materials from ports to plants and betweenplants totaled 669,000 tons, which is projected to increase to 1,735,000 tonsin 1982, as indicated in the table below:

Mexico - Rail Shipments of Fertilizer Materials fromPorts of Import and between Plants a/ b/

(in '000 tons of product)

Products 1976 1982

Phosphate Rock 244 550Anhydrous Ammonia 248 696Sulfur 123 389Potash 54 100

Total 669 1,735

a/ Excludes tonnage consumed at plants at ports of import,such as Pajaritos, Coatzacoalcos, Lazaro Cardenas.

b/ Based on data of projected raw material requirements,excluding ammonia shipments.

In addition to these materials, 3.1 million tons of finished fertilizer prod-ucts were shipped in 1976, which are projected to rise to above 5 million tonsby 1982. A total of about 6.7 million tpy -- nearly an 80% increase over 1976-- of raw, intermediate and finished products will have to be moved by thetransportation system in Mexico, which may have already reached its limits insome areas. An increased product movement of such magnitude, totally dependenton rail transportation, is likely to create strains on FERTIMEX' distributioncapability if adequate steps are not taken to identify and resolve potentialbottlenecks. Agreement has, therefore, been reached that FERTIMEX will completenot later than August 31, 1980, a detailed plan to meet its transportationneeds after Project completion.

F. Fertilizer Prices and Pricing Policy

4.24 Producer and farmer fertilizer prices in Mexico are controlled bythe Government. The primary objective of the Government's pricing policyhas been to supply farmers with fertilizer at a low cost to stimulate its useand thus increase crop output. Development of fertilizer prices since 1962is given in Annex 4-6. Current fertilizer prices, at the factory and farmers'level, are low compared to other countries despite price increases of 10% inOctober 1976, 25% in March 1977, 15% in April 1978 and 16% in January 1979. 1/

1/ This last price increase is still not effective on retail level sincethe 16% price increase in January 1979 was offset by the simultaneousintroduction of a 16% discount to the farmers.

- 27 -

A comparison of recent retail fertilizer prices in Mexico with those in theUnited States and India is given beLow.

Mexico - Comparative Farmer Fertilizer Prices in 1978(US$/ton in bags)

Mexican Prices

a/ b C/ d/ as % of AverageProducts Mexico-' - India- US;- Indian/US Prices

Ammonium Sulphate (21% N) 55 109 128 47%,Urea (46% N) 116 180 185 64%.Ammonium Nitrate (33.5% N) 91 - 153 59,'Anhydrous Ammonia (82% N) in tanks L21 - 171 71,%Single Superphosphate (20% P 205 ) 52 42 123 64%Triple Superphosphate (46% P2 5) 130 191 168 72%Diammonium Phosphate (18-46-U) 164 257 203 71x%Potassium Chloride (60% K 20) 71 94 112 69%'Compound Fertilizers17-17-17 117 210 190 59% -

a/ Delivered price includes US$12 per ton for transportation.b/ US$1 = Mex$ 22.5.c/ US$1 = Rp 8.6.d/ For products in bulk, US$15 adcled to arrive at bagged fertilizer price.

4.25 The current fertilizer pricing system in Mexico consists of anofficial uniform price at all railhead warehouses. From rail points, fer-tilizer is shipped by truck to other warehouses in the sales area. Thiscost of trucking is added to the official rail depot price, to calculatethe final retail price at such warehouses. In addition to the officialretail price, the farmer is charged 4% sales tax and a charge of Mex$ 5/tonon AS and SSP and Mex$ 12/ton on all other fertilizers. This later chargeis in turn passed on to the Ministry of Agriculture by FERTIMEX for fertil-izer promotion and technical assistance. The table below shows, as an exam-ple, the build up of the farmer (retail) price for urea.

Mexico - Sample Build up of Bagged Urea Retail Price in January 1979(in Mex$/ton)

At WarehouseAt Railway offDepot Rail Point

Official Rail Deposit Price 3,599 3,599Minus Discount 576 576Effective Price at Rail Deposit 3,023 3,023Trucking to warehouse off rail point,e.g., Tierra Blanca, Vera-Cruz - 200

Sub-total 3,023 3,2234% Sales Tax 121 129Patronage Charge 12 12

Final Retail Price 3,156 3,364

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4.26 Net prices currently obtained by FERTIMEX are substantially below

international prices. For example, compared to its ex-railhead price of about

US$134/ton (Mex$ 3,023/ton) for urea, the urea import prices, even at their

current low level, are about US$175/ton CIF. FERTIMEX is able to sell its

domestic production at those low levels primarily due to the low price at

which it buys ammonia from PEMEX (para 7.03), though as a result of these

prices and as discussed in Chapter III it is unable to generate adequate

profits. For the sale of higher cost imported products, the Government

offsets FERTIMEX losses through a compensation system (para 3.14).

4.27 As shown in the following table, the relative relationship between

prices of agricultural crops and fertilizers improved substantially during

1962-72 as a consequence of government policy to stimulate fertilizer use

and agricultural production. While due to the recent fertilizer price in-

creases the relationships for many crops are currently not as favorable as

in 1972 they are still at only two-thirds of those in 1962 and at levels

generally considered adequate to encourage farmers to increase fertilizer

application rates.

Mexico - Kilograms of Crop Needed to Purchase 1 kg of Nutrient

Corn Wheat Cotton Beans Rice Sorghum

N P205 N P205 N P205 N P205 N P205 N P205

1962 4.05 2.68 3.55 2.35 4.05 2.68 1.85 1.22 3.60 2.38 5.89 3.89

1972 3.28 3.08 3.09 2.90 1.28 1.20 0.56 0.53 1.33 1.25 4.18 3.93

1976 1.94 2.33 2.35 2.82 1.55 1.86 0.82 0.99 1.65 1.96 2.34 2.80

Nov.1977 1.85 2.10 2.61 2.98 2.02 2.30 0.97 1.11 1.79 2.03 2.64 3.00

4.28 The table below compares the number of kilograms of wheat and rice

needed to purchase a kilogram of nutrient in Mexico and in five other coun-

tries:

Various Countries - Kilograms of Wheat and Rice Neededto Purchase 1 kg of Nutrient a/

Wheat Rice

N P205 N P205

USA 4.59 3.92 2.69 2.29

India 4.05 4.59 2.66 3.02

Italy 2.13 1.92 1.67 1.53

Pakistan 2.81 1.81 1.03 0.66

Mexico 2.72 2.86 1.29 1.61

a/ Data for 1973-75 period except for Mexico which gives

an average of the 1972/76 data from table in para 4.27.

The above indicates that it takes considerably fewer kilograms of wheat and

rice to purchase a kilogram of nutrient in Mexico than it does in the United

States and India and very roughly (at least for rice) the same as in Italy.

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4.29 Until now, the Government's; main concern, while setting fertilizerprices, has been to stimulate increased agricultural crop output by supplyingthe farmers with low-priced fertilizer. At the same time, it has carefullyavoided any actions that could have an inflationary impact on an economyalready experiencing double digit inflation rates. The Company thus se]Llsboth domestically produced and imported fertilizers at retail prices wellbelow the international prices, causing FERTIMEX' poor financial performanceand serious liquidity problems (para 3.16). The Company has managed to con-tinue operations by obtaining payments against cash shortfalls on a month-to-month basis (even the payment of compensatory payments described in paras3.14-3.16 was until recently not automatic). As a result, FERTIMEX hasbeen currently acting more as government department, fully dependent on theGovernment's budgetary process, than as an autonomous commercial company re-quired by its bylaws. Moreover, it has become a major burden on the nationalbudget. However, the Government is now becoming keenly aware of the need tomake public sector companies like FERTIMEX financially self-sufficient inorder to reduce their increasing demands on the national budget. Duringappraisal the Bank extensively discussed with the government agencies con-cerned the shortcomings of the preserLt pricing policy and also advised theGovernment of fertilizer pricing systems in other countries which permitfertilizer supply to farmers at attraLctive prices while ensuring acceptablereturns to the fertilizer producers.

4.30 The Government has recognized the need to develop a pricing policywhich would allow FERTIMEX to become financially self-sufficient and earn anacceptable return on investment, without adversely affecting fertilizer con-sumption. Since development and implementation of such a policy that willallow higher ex-factory prices is essential to FERTIMEX' financial viabilityand creditworthiness as a borrower (para 3.16), the Government has agreed thatit will implement a two-tier pricing system which would increase the effectivefarmer price more gradually than the ex-factory price by compensating FERTDIEXwith the difference. The new pricing policy will involve a gradual increasein ex-factory prices sufficient to enable FERTIMEX to earn before interest andafter tax a return on assets of at least 3.5% for 1980, 1981 and 1982 and 8%for 1983 and thereafter un