Document of The World Bank Report No: 17030-CHA PROJECT APPRAISAL DOCUMENT ONA PROPOSED LOAN IN THE AMOUNT OF US$63 MILLION AND A PROPOSED GEF GRANT OF US$22 MILLION EQUIVALENT TO THE PEOPLE'S REPUBLIC OF CHINA FOR AN ENERGY CONSERVATION PROJECT February 26, 1998 Energy and Mining Development Sector Unit China Country Unit East Asia and Pacific Regional Office CURRENCY EQUIVALENTS (As of October 1997) Currency Unit = Yuan Yuan 1.00 = US$0.12 US$1.00 = Yuan 8.3 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS ABD Asian Development Bank CAS Country Assistance Strategy CO2 Carbon Dioxide DO Development Objective DSM Demand-Side Management EBRD European Bank for Reconstruction and Development EC European Communities ECIDC Energy Conservation Information Dissemination Center EMC Energy Management Company ESCO Energy Service Company GEF Global Environment Facility GHG Greenhouse Gas lAS International Accounting Standards IBRD International Bank for Reconstruction and Development IP Implementation Progress NGO Nongovernmental Organization PCR Project Completion Report PDF Project Development Funds PMO Project Management Office SETC State Economic and Trade Commission SO2 Sulfur Dioxide SPC State Planning Commission TSP Total Suspended Particulates UNDP United Nations Development Prograrn VAT Value-Added Tax Vice President Jean Michel Severino, EAP Country Director Yukon Huang, EACCF Sector Manager Yoshihiko Sumi, EASEG |Task Manager Robert Taylor, Senior Energy Economist, EASEG CONTENTS A: Project Development and Global Objectives ................................... ..........................2 1L. Project development objective and key performance indicators ....................................2 B: Strategic Context ............................................................2 I a. Sector-related Country Assistance Strategy (CAS) goal supported by the project ............................................................2 lb. Consistency with GEF Operational Program .............................................................2 2. Main sector issues and Government strategy ............................................................. 2 3. Sector issues to be addressed by the project and strategic choices ............... .................3 C: Project Description Summary .............................................................6 la. Project components .............................................................6 lb. Phase II EMC Expansion .............................................................7 2. Key policy and institutional reforms supported by the project .................. ....................8 3. Benefits and target population .............................................................8 4. Institutional and implementation arrangements ................................... ; . 8 D: Project Rationale ........................................9 1. Project alternatives considered and reasons for rejection ................................ ..............9 2. Major related projects financed by the Bank, and/or other development agencies (completed, ongoing and planned) ....................................................... 10 3. Lessons learned and reflected in the project design ..................................................... 10 4. Indications of borrower commitment and ownership ................................................... 10 5. Value added of GEF and Bank support in this project ........................................ ......... 10 E: Summary Project Analysis .......................................................... 11 1. Economic .......................................................... 11 2. Financial analysis .......................................................... 12 3. Technical analysis .......................................................... 12 4. Institutional .......................................................... 12 5. Social .......................................................... 12 6. Environmental assessment .......................................................... 12 7. Participatory approach .......................................................... 13 F: Sustainability and Risks .......................................................... 13 1. Sustainability .......................................................... 13 2. Critical Risks .......................................................... 13 3. Possible Controversial Aspects .......................................................... 14 G: Main Loan Conditions .......................................................... 14 1. Effectiveness Conditions .......................................................... 14 2. Other .......................................................... 14 H. Readiness for Implementation .......................................................... 15 I. Compliance with Bank Policies .......................................................... 16 Annex 1: Project Design Summary .......................................................... 17 Annex 2: Energy Conservation in China: Making the Transition to the Market ........... ............. 20 Annex 3: Project Description and Costs .......................................................... 25 Annex 4: Project Justification, Incremental Costs, and Benefit-Cost Analysis .......................... 35 Annex 5: Financial Aspects of the Energy Management Companies ...................... ................... 45 Annex 6: Procurement and Disbursement Arrangements .......................................................... 56 Annex 7: Project Processing .......................................................... 61 Annex 8: Documents in the Project File .......................................................... 62 Annex 9: Statement of Loans and Credits ........................................................... 63 Annex 10: Country at a Glance .......................................................... 67 China Energy Conservation Project Appraisal Document East Asia and Pacific Regional Office China Date: 02/26/98 Task Team Leader/Task Manager: Robert Taylor Country Manager/Director: Yukon Huang Sector Manager/Director: Yoshihiko Sumi Project ID: CN-PE-3606 Sector: Energy Program Objective Category: Environmentally Sustainable Dev. Lending Instrument: Specific Investment Loan Program of Targeted Intervention: [] Yes [X] No Project Financing Data [X] Loan [] Credit [] Guarantee [] Other [Specify] For Loans/Credits/Others: Amount (US$ M/SDR M): IBRD Loan $63 million, GEF Grant $22 million Proposed terms: [ ] Multicurrency [X] Single currency, specify US dollars Grace period (years): 5 [ ] Standard Variable [ Fixed [X] LIBOR-based Years to maturity: 20 Commitment fee: 0.75% Service charge: n.a. Financing plan (US$ M): Source Local Foreign Total EC Grant /a 2.2 2.3 4.5 GEF Project Grant /b 5.3 16.7 22.0 IBRD Loan 6.5 56.5 63.0 SETC Grant 7.0 0.0 7.0 Domestic loans (through SETC) 27.8 3.1 30.9 EMC internal sources /c 23.4 0.0 23.4 Total 72.2 78.6 150.8L L/ Effective June 1997. L Total GEF grants for this project are US$22.7 million, including GEF Project Development Grants of US$0.7 million approved in 1996. L/ Internal funds for reinvestment in projects by the EMCs, derived from project revenues, are projected to total about US$620 million over 10 years. This table only includes allocation of internal funds to cover taxes due on GEF/IBRD/SETC-financed investments. Borrower: People's Republic of China Guarantor: Responsible agency(ies): State Economic and Trade Commission Estimated disbursements (Bank FY/US$M): 1999 2000 2001 2002 2003 2004 2005 2006 GEF Grant Annual 7.4 7.1 5.2 1.9 0.3 Cumulative 7.4 14.5 19.8 21.7 22.0 IBRD Loan Annual 3.8 5.7 7.8 10.1 11.0 11.3 9.5 3.8 Cumulative 3.8 9.5 17.3 27.4 38.4 49.7 59.2 63.0 Project implementation period: seven years Expected effectiveness date: 09/98 Expected closing date: 06/06 Page 2 A: Project Development and Global Objectives 1. Project development objective and key performance indicators (see Annex 1). The objective of the project is to achieve large, sustained and growing increases in energy efficiency, and associated reductions in growth of carbon dioxide emissions and other pollutants. The project will achieve this by (a) introducing, demonstrating and disseminating new project financing concepts and market-oriented institutions to promote and implement energy efficiency measures in China, and (b) developing a more efficient national energy conservation information dissemination program. The project is designed to assist in the transition of China's energy conservation activities from a system based on planned economy concepts and energy use quotas to a more market-oriented system, which can be sustained over time and grow with China's economy. The project would support the establishment and pilot demonstration of Energy Management Companies (EMCs) in China for the first time, followed by a program to support proliferation of the EMC concept. These commercial companies will be engaged in self-sustaining energy efficiency investments through energy performance contracting. In addition, the project also seeks to achieve increases in energy efficiency by strengthening China's national efforts to provide improved access to specific information concerning successful domestic experiences in energy efficiency measures and projects, geared in particular to financial decision makers in enterprises. Key performance indicators will include quantified energy savings and associated carbon dioxide (CO2) emissions reduction resulting from the project. B: Strategic Context la Sector-related Country Assistance Strategy (CAS) goal supported by the project (see Annex 1). CAS document number: 16321-CHA Date of latest CAS discussion: February 25, 1997 The project supports the twin CAS objectives of alleviating infrastructure constraints and safeguarding the environment, by increasing the supply of useful energy to industrial and commercial users through environmentally attractive increases in the efficiency of end-use energy-intensive equipment. lb. Consistency with GEF Operational Program: China ratified the IJN Framework Convention of Climate Change on January 5, 1993. The project is consistent with Operational Program #5 of the GEF Operational Strategy for climate change, where one of the long-term mitigation measures is to remove the barriers to energy conservation and energy efficiency. 2. Main sector issues and Government strategy: The need to improve the efficiency of energy use in parallel with development of additional energy supply has been a cornerstone of China's energy policy for over 15 years. Although substantial success has been achieved, it is widely recognized both inside and outside of China that far greater improvements in the efficiency of energy use are critical to the country's economic and environmental future. All recent macroeconomic forecasting work on China has shown that continued rapid economic growth is not physically, financially or environmentally sustainable without dramatic further improvements in energy efficiency. Improving energy efficiency is a main pillar of China's environmental protection strategy, especially as a means to abate local and regional air pollution and increases in greenhouse gas (GHG) emissions. Enormous potential for cost-effective improvements in energy efficiency remains untapped in China, especially in the industrial sector, which is expected to continue to dominate energy consumption in China for decades. The strategic importance of and remaining cost-effective potential for energy Page 3 efficiency measures is well documented in recent sector work completed by the Bank and a wide range of other studies completed both in China and abroad.' China's existing energy conservation system is among the most extensive in the world. During the 1980s, China successfully developed a comprehensive energy conservation program, including major policy directives, procedures, regulations, technical assistance programs, and project financing initiatives. The institutional framework includes a series of specialized energy conservation units at national, provincial and county/prefecture-level government units, operating under the State Economic and Trade Commission (SETC) and its provincial and local affiliated commissions. The system was quite effective under the centrally planned economic system, taking advantage of the well-established systems of industrial enterprise energy input quotas and government investment funding mechanisms for state- owned enterprises. With the ongoing conversion of China's economic system to a market economy, however, the established system for promoting energy conservation must be transformed to operate more effectively in a new environment. Without timely change, many of the critical gains in capacity building achieved during the last decade and a half may be lost, especially the major gains achieved in development of technical expertise in energy conservation project work. The Government recognizes the need to adapt China's energy conservation system to maximize the play of market forces, and strongly supports the development of market-based energy efficiency initiatives. Major reforms in retail energy pricing pursued during the late 1980s and 1990s have brought average retail energy prices to levels at or above the cost of supply. As a result, of 16 case studies of typical energy conservation investments in manufacturing enterprises completed for the China GHG study, all exhibited financial rates of return of over 15 percent, and three quarters exhibited returns of 20 percent or higher. Many challenges, however, are involved in the conversion to market-based energy efficiency initiatives. Because many of the administrative measures previously used to promote energy conservation are now becoming inapplicable, promotion efforts must be built on the interest of enterprises themselves to undertake energy efficiency measures, as a means to increase enterprise profits and/or meet environmental regulations. New and different financing approaches and mechanisms are needed, and promotion activities must better focus on and utilize the direct self-interest of enterprises. Support for the introduction of market-oriented approaches is especially important at this phase, when market incentives for energy conservation are increasing, but knowledge among most enterprise managers of the most effective energy efficiency options is weak, and the institutional system for promoting energy conservation has little experience with the types of methods and mechanisms which can best assist enterprises in the new environment. 3. Sector issues to be addressed by the project and strategic choices: Energy conservation investments, especially in industry, can be categorized into three types. A first type includes investment in energy efficient processes and equipment in new plant, as part of new plant design. A second type includes packages of substantial investments to restructure and modernize industrial plants, focusing usually on adoption of more efficient production processes. Examples of this second type include conversion of steelmaking furnaces to modem technology, conversion of cement plants from wet to dry process, conversion of existing housing blocks to use of piped gas for cooking, etc. These restructuring projects typically involve large-scale investment, medium-level rates of return, and major benefits in expanded production or improvement in product quality, as well as substantial See, for example, China: Energy Conservation Study (Bank Report 10813-CHA, February 4, 1993), and China: Issues and Options in Greenhouse Gas Emissions Control (Summary and four major subreports on energy efficiency), a GEF-financed joint report of the Chinese Government, UNDP and the World Bank, 1994. Page 4 energy savings. Case studies have shown that enterprise managers in China are usually keen to undertake these investments, but face major constraints arranging adequate credit and overcoming a series of enterprise efficiency problems stemming from incomplete state-owned enterprise reforms. A third type of investment includes relatively small-scale measures, usually involving replacement or addition of specific equipment, and focused primarily on energy savings alone. Examples include replacement of traditional lighting equipment with high-efficiency lamps, adoption of high-efficiency and/or variable- speed motors and associated fans and pumps, and boiler and steam system modifications to improve combustion, increase heat recovery and/or reduce steam loss. The total energy savings of each investment are fairly small, but the scope for implementation is very broad, so that the potential for aggregate energy savings through these types of projects is very high. Investment costs are relatively low, and rates of return of well conceived projects are quite high, but constraints exist in mobilizing implementation. While this project includes some support for the accelerated implementation of some of the second type of projects, e.g., in the information component, the primary focus of this project is on the third type of energy conservation investments. Detailed case studies on energy efficiency projects with wide potential across China showed that many projects would yield sound life-cycle financial returns today, but remain unimplemented. Rates of return for the third type of energy conservation investments typically exceed 20 percent, while payback period range from 1 to 5 years. Many of the barriers identified in case studies in China which constrain the implementation of these commercially-tested and financially viable projects are similar to those found in other countries: * Inadequate Information. Enterprises and individuals lack information about energy-saving investments, especially on financial aspects and the implementation experiences of others. China has developed various mechanisms for distribution of technical information on energy efficient technologies and renovation measures within the energy conservation community. The system falls far short of current needs, not only in terms of coverage, but particularly in terms of focus. Little information is available for the enterprise managers concerning how specific energy conservation projects can yield direct financial benefits to enterprises, practical implementation measures from experience, impacts on production (if any), etc. - Technology Transfer Barriers. While some state-of-the-art energy efficient technologies have been introduced in China, many have yet to be widely distributed. * Risk. Perceived technical and financial risks to enterprises in adopting innovative energy saving technologies are very high in China. Fears that a new technology may not work, could interrupt production, or may take time to perfect, all inhibit enterprise management from adopting new energy-saving technologies or practices. * Real and Perceived Insignificance of many Energy Efficiency Investments. Many worthwhile energy efficiency investments are relatively small, and while they may yield sound financial returns, the value of the savings achieved typically is only a small percentage of enterprise operating costs. Enterprise managers are most interested in expanding production and increasing market share, and, especially if there is some perceived risk involved, they often show little interest in small projects yielding relatively small savings in operating costs. * High Transactions Costs. Especially when technologies are relatively new and unfamiliar to enterprises, energy efficiency projects often carry high costs (especially high opportunity costs of key skilled enterprise personnel) for obtaining and checking information, planning and design, arranging financing (including internal arrangements), implementation scheduling, monitoring initial performance and implementing necessary adjustments, etc. Especially where the benefits are considered small, enterprises are reluctant to incur these costs. Page 5 * Difficulties in Arranging Financing. Interested enterprises have insufficient access to project financing for upfront investment costs for projects to reduce operating costs. Credit for all types of investment projects is difficult to obtain in China today, but domestic banks are particularly reticent to lend for energy conservation projects. Financial institutions in China (and elsewhere) are generally not familiar or adept at analyzing the financial aspects of energy efficiency projects, and hence less willing to extend credit for these projects. * Institutional Constraints. China's present energy conservation system, while extensive, is not geared to provide the type of support needed by enterprises under the market system, and is currently not well placed to help enterprises overcome many of the barriers listed above. GEF Energy Efficiency Strategy for China. The overall GEF program to assist China to reduce GHG emissions through energy efficiency improvements includes a portfolio of projects that have been approved or are under preparation included are two UNDP-implemented technical assistance projects (the approved Energy Conservation in Township and Village Enterprises Project, and the proposed High- Efficiency Refrigerator Project) and two Bank-implemented investment projects (the approved Efficient Industrial Boilers Project and this proposed project). As a whole, the program seeks to alleviate the barriers listed above through a combination of mutually reinforcing measures to: (a) improve access to relevant information, (b) facilitate the transfer of advance technology, especially for production of high- efficiency equipment, and (c) develop institutions and financing mechanisms that can more effectively spur energy conservation investment under the market economy. The TVE, boilers and refrigerator projects each combine a series of efforts to alleviate barriers for a specific subsector. The TVE project focuses on the development of interventions specifically geared for this growing, collectively owned sector, where energy efficiency work has traditionally been undersupported in China. The boiler and refrigerator projects focus on technology transfer for domestic production of more efficient, new energy-using equipment, and the information dissemination, institutional development, and policy strengthening needed for interventions to be sustainable. This project, combined with a proposed Phase II follow-up effort, will address the identified barriers through introduction of energy performance contracting and an improved information dissemination program. Energy performance contracting is an energy conservation project financing and implementation method which has been successfully employed in North America and Western Europe since the late 1970s. It involves joint implementation of an energy conservation project by an Energy Service Company (ESCO)-or, as termed in China, an Energy Management Company (EMC)-together with a "host enterprise," according to an "energy performance contract." The ESCO/EMC undertakes project design, arranges financing, and installs and usually maintains the key equipment in the host enterprise. In exchange for these services and shouldering most of the project risk, the EMC is compensated from a portion of the money saved by the host enterprise on its energy bills. In China's case, the concept is being developed, at least initially, in a manner similar to equipment leasing with a buyout provision: the EMCs purchase and install more energy efficient equipment and are compensated monthly from the resulting actual savings until the investment cost and a reasonable profit have been recovered, after which equipment ownership reverts to the host enterprise. The energy performance contracting concept is most applicable for the third type of energy conservation projects mentioned above, where projects are small, easily replicated, and energy savings are relatively easy to verify. The Government is particularly keen to develop energy performance contracting, which it considers to be a financing and technology dissemination mechanism of great potential for China's evolving market economy. Compared with traditional financing mechanisms, use of the energy performance contracting mechanism as designed in this project: (a) helps to overcome host enterprise reticence due to lack of Page 6 information and perceived risk by placing responsibility for implementation and risk burdens on the EMC developer, (b) helps to overcome enterprise reticence due to perceptions of small projects as being financially not significant enough to warrant development by placing the burden for development primarily on the EMC, (c) reduces transaction costs for small projects through development of a high volume of technically similar product lines within an EMC, and (d) eases financing constraints in host enterprises by utilizing savings in operating costs to directly pay for investment. The Government hopes that increasing use of this mechanism can make the existing energy conservation support system more relevant for today's needs. C: Project Description Summary la Project components (see Annex 2for a detailed description and Annex 3for a detailed cost breakdown): Component Category Cost Incl. % of Bank % of Contingencies Total financing Bank/GEF (US$M) (US$M) financing 1. EMC Demonstration Physical, institutional building 137/a 90 15 (GEF) 63 (IBRD) } 57 2. Information Dissemination Physical, institutional building 10 7 5 (GEF) 50 3. Program Management and Policy, institutional building, 4 3 2 (GEF) 50 Monitoring project management Total 151Lf 100 /a Figures do not include the GEF Project Development Grants, costs associated with the planned Phase 11 EMC follow-up effort, or over US$600 million of energy conservation project investment by EMCs financed through reinvestment of funds over a I 0-year period. Energy Management Company Demonstration. Under this core component, three demonstration EMCs will be developed, begin operation, and expand as commercial businesses. The three EMCs will adapt, operationalize and develop energy performance contracting, as developed by ESCOs in other countries, for the first time in China. The EMCs will undertake investment projects in other "host" enterprises. Although additional financing mechanisms may be developed over time, in this demonstration phase the EMCs will finance the investment, shoulder the technical and financial risk, and initially own the equipment installed in the host enterprises. The EMCs will be paid by the host enterprises from a share of the value of the energy savings actually achieved, according to an energy performance contract. The EMCs will receive most of the money saved by the energy efficiency investment at the beginning, until it is fully compensated for the investment, operating costs, risks undertaken and a reasonable profit. Thereafter, the equipment ownership normally would be transferred to the enterprises, and the enterprises receive all of the further financial benefits of energy savings. As developed in North America, if the EMC selects good projects and. manages them well, it should earn profits for steady growth. The host enterprises incur less risk, provide no investment capital, and eventually own more efficient equipment and enjoy accompanying reduced energy costs. Geared for provincial-level operations, the EMCs were established as shareholding companies in 1996 in Beijing Municipality, and Liaoning and Shandong Provinces. The companies have received a large amount of technical assistance financed with Global Environment Facility (GEF) Project Development Funds. Operations are being developed gradually, with opportunities to leam from practical experience. Page 7 Execution of an ECU 4 million (about US$4.5 million) grant from the European Commission began in June 1997, supporting the implementation of the first series of energy performance contracting projects and further technical assistance. GEF financing will support further implementation of pilot projects to adapt the energy performance contracting concept for different technologies, consumer types and contract variations. IBRD funds will support replication of successful pilot projects, in a series of "project lines" in each EMC, and EMC growth. The SETC has arranged 300 million yuan (currently equivalent to about US$36 million) of domestic credit at commercial terms, for counterpart financing of pilot projects and further EMC growth. Total investments in energy conservation projects to be undertaken by the three EMCs forecast during 1997-2006 is expected to amount to about US$730 million, as host enterprise payback to the EMCs should be completed within 18-30 months for most energy performance contracts, and financing from reinvestment will grow to large levels during the middle and later years of the project. Information Dissemination Component. This component will support the development of a new system to provide practical information on energy conservation project results to Chinese enterprise managers. The system will be operated by the new Energy Conservation Information Dissemination Center (ECIDC), established on January 9, 1998, which will function under a performance contract with SETC's Project Management Office (PMO). New information products will be developed with particular emphasis on financial results actually achieved by enterprises, problems and solutions during implementation, any impacts on main enterprise production or other key risks, and contact information on enterprises with relevant experience. Dissemination work will focus on influencing enterprise decisionmakers, and ECIDC's performance will be evaluated based on how many enterprises actually use the information provided to implement energy conservation projects. The Center's regular operations will be funded by the Government, including SETC grant financing of US$5 million during the initial five years to support the core costs of ECIDC and a core level of product development and dissemination. GEF grant financing of US$5 million will support training and institutional capacity building, a portion of product development and dissemination, especially during the early, trial years, and program evaluation and monitoring. Program Management and Monitoring Component. This component will be executed over a five-year period by the Project Management Office (PMO) of SETC. The component will support the activities of two distinct units in the PMO: the EMC Development Unit and the Project Management Unit. The purpose of the EMC Development Unit is to promote and assist the creation of new EMCs in China by any interested domestic or international parties. The success of the program and the unit staff will be measured by the number of new EMCs created and the successful operation of these EMCs. Activities of this unit will include provision of information, liaison and provision of technical assistance to foreign ESCOs interested in possible China operations, to Chinese financial institutions, and to Chinese businesses interested in developing energy performance contracting. The EMC Development Unit also will assist the PMO in the preparation of the proposed Phase II effort (below). The second unit, the Project Management Unit, will provide operational support and technical assistance for the implementation of the two other project components, provide policy advice to the Government, and implement a series of training activities for staff and experts nominated by the PMO. l b. Phase II EMC Expansion. While the proposed EMC Demonstration Component will demonstrate the EMC concept in three provinces of China, full success in removing barriers to EMC development in China (and greatest cost- effectiveness) requires the expansion and dissemination of the concept to other EMCs throughout China, Page 8 following up on the work of the EMC Development Unit of the PMO. Additional support under a Phase II will therefore be necessary to develop a variety of different types of EMCs in many parts of China, including joint ventures with foreign firms. It is therefore expected that additional incremental cost GEFsupport, the size of which will be determined during implementation of the EMC Demonstration Component, will be sought for a Phase II EMC Expansion about 18 months after effectiveness of this first Energy Conservation Project. Preparation and implementation of the Phase II project is scheduled behind the first project so that its detailed design can build upon the implementation experience of the initial demonstration EMCs. Financing for the preparation of Phase 11 is included in the Program Management and Monitoring Component of this Phase I project. Documentation for the Phase II proposal to the GEF Council will note and include: (a) completion of an evaluation of implementation results of the initial pilot project in the EMC Demonstration Component, (b) assessment of lessons learned, identification of issues requiring resolution, and proposed solutions; (c) completion and evaluation of a conference on EMC results with the domestic financial community, and (d) arrangement of suitable counterpart financing/cofinancing. 2. Key policy and institutional reforms supported by the project: The project supports major institutional reforms through the development of a new energy conservation investment financing and implementation mechanism, and a new type of information dissemination system. However, these reforms are specific to the energy conservation field. 3. Benefits and target population:. The project will provide large, cost-effective reductions in energy use, GHG emissions and other pollutants (e.g., total suspended particulates and sulfur dioxide). Direct benefits include (a) reduction in energy use from the operation of the three EMCs, totaling an estimated 45 million tons of coal equivalent (tce), and associated carbon dioxide emissions reduction of 34 million tons carbon, over the life of the projected investments undertaken during the next 10 years; and (b) estimated energy savings of 24 million tce, and associated carbon dioxide emissions reduction of about 18 million tons carbon, over the life of investments fostered through 10 years of operation of the new information program. Yet, if this project and Phase II efforts are successful, even larger and more important benefits can be achieved through dissemination of the new energy conservation investment financing mechanisms and institution building on a wider scale in China, based on this demonstration of the energy performance contracting concept (see also Annex 4). 4. Institutional and implementation arrangements: The SETC will be responsible for coordination of project implementation, assisted by other agencies and research units. The SETC, and the affiliated Economic and Trade Commissions at provincial, prefecture and county levels, are responsible for implementation of the country's energy conservation policies and organization of the government's efforts to renovate existing enterprises. They manage and allocate state funds provided in the national economic plans for this purpose. The SETC has established a Project Management Office (PMO) to oversee project preparation and implementation, chaired and partially staffed by the Department of Resource Savings and Comprehensive Utilization, with additional expert staff from the Energy Research Institute of the State Planning Commission, the Beijing Energy Efficiency Center, and other units. The PMO also is assisted by a variety of domestic and intemational consultants. The PMO will coordinate the implementation of the EMC Demonstration Component; implement the Information Dissemination Component, through ECIDC operating under its direct supervision; and directly implement the Project Management and Monitoring Component. The three provincial-level EMCs will be the project beneficiaries for the EMC Demonstration Component, financed by the EC and GEF and all of the IBRD loan. Government coordination in the provinces is Page 9 managed by the provincial Economic and Trade Commissions at a high level. IBRD loan funds will be provided under subsidiary loan agreements between the Ministry of Finance and provincial Finance Bureaus, and between provincial Finance Bureaus and each EMC, with provincial government repayment guarantees. GEF funds for the EMC Demonstration Component will be provided under subsidiary grant agreements, similar to the subsidiary agreements under the EC grant. Step-by-step monitoring and evaluation are critical in this project, and will be conducted by the EMCs and PMO with support under the project. Biannual project implementation reports from each EMC must include specified monitoring data and evaluations for each of their demonstration projects, as a basis for mid-course correction, for definition of key implementation issues requiring government attention (with support under the project management and monitoring component), and for definition of the specific activities for the Phase II EMC Expansion. Following the experience of a similar UK program, ECIDC also must monitor and verify the effect of its information dissemination work, in terms of energy savings by affected enterprises, as will be specified in the performance contract between ECIDC and the SETC. The Bank has reviewed the financial management capabilities of the three EMCs. The EMCs, as new companies established in 1996, are learning the energy performance contracting business and improving project management capacity quickly with the benefit of a large amount of technical assistance and training both during project preparation and implementation (see Annexes 3 and 5). Special emphasis has been placed on the development of financial management and reporting capacity to operate and control companies of this nature; provision of training to financial personnel; development and implementation of more sophisticated financial planning and control functions; production of monthly cost and variance reports by element and process, cash budgets and proforma financial projections; and definition of financial policy and appropriate procedures. The EC Grant includes a substantial financial management and reporting technical assistance package for this purpose, to be implemented in 1998. Further follow- up assistance will be organized by SETC under the Project Management and Monitoring Component as and when necessary. D: Project Rationale 1. Project alternatives considered and reasons for rejection: The project team and Government counterparts also considered the development of a line-of-credit operation to support industrial energy conservation investments. Although such an operation might have been simpler to develop for the Government counterparts, they strongly preferred the energy performance contracting concept. Given the issues involved in financial intermediary operations for industrial renovation generally, and the mediocre experience of past Bank projects in other countries involving lines of credit for energy conservation specifically, the Bank team also opted for the new approach. The concept of promoting electricity conservation by electric power utilities through consumer rebates or subsidies, as practiced in North American demand-side management (DSM) programs, was rejected due to a desire to avoid consumer subsidies and the fact that China's current power price regulation system is not conducive to recovery of such costs through the power tariff. Page 10 2. Major related projects financed by the Bank, and/or other development agencies (completed, ongoing and planned): Sector issue Project Latest Supervision (Form 590) Ratings (Bank-financed projects only) Implementation Development Progress (IP) Objective (DO) Bank Industrial Energy Conservation Hungary: Industrial Energy Diversification and n/a n/a Conservation (PCR, 1993) Hungary: Second Industrial Energy and n/a n/a Conservation (PCR, 1994) Bangladesh: Industrial Energy Efficiency Project n/a n/a (PCR, 1992) Indonesia: Industrial Energy Conservation n/a n/a Project (PCR, 1994) Technology Transfer China: Efficient Industrial Boilers (GEF) S S Power Development Yangzhou Thermal Power S S Ertan II Hydroelectric S S Other development agencies Asian Development Bank: China: Energy Conservation I Industrial Energy Conservation IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) 3. Lessons learned and reflected in the project design: Energy projects in the current China portfolio (January 1998) all have highly satisfactory or satisfactory ratings. The energy conservation projects listed above (and several other additional earlier Bank projects) all involved lines of credit for industrial energy conservation. The implementation record for these types of projects has been mixed-while some success has been achieved (the first two projects in Hungary, and the ADB China project), many have had difficulty disbursing and some (Bangladesh) were canceled without disbursement. Problems have included changes in government or other institutional problems and high processing costs to potential subborrowers, but the constraints listed in Section B3 also dampened interest in borrowing. The proposed project adopts a new approach to overcome these constraints. 4. Indications of borrower commitment and ownership: Borrower commitment and ownership is high. At least 20 million yuan in equity financing already has been invested to establish each EMC, and the SETC has allocated US$43 million equivalent in loan and grant financing for the project. The SETC and provincial Economic and Trade Commissions have contributed over US$700,000 equivalent for project preparation. Project preparation has been well organized, and counterparts have completed a variety of complex tasks on time and efficiently. The SETC and EMCs have used international technical assistance effectively, and implementation of the EC grant is proceeding satisfactorily. Provincial Government support is strong and at a high level, especially in Shandong and Liaoning. 5. Value added of GEF and Bank support in this project: The different roles of the EC, GEF and IBRD financing, allowing first introduction and demonstration of the new energy performance contracting concept, followed by broader development and dissemination, Page 11 are critical for the project as a whole. Bank leadership in introducing the new energy performance contracting concept has been and will continue to be very important. GEF support is essential for the implementation of the first phases of the project, focusing on the introduction, adaptation and demonstration of new concepts. For the EMC Demonstration Component, the lack of actual, on-the-ground experience with the energy performance contracting concept, requiring adaptation to Chinese legal, taxation, financial and institutional systems, is the major barrier that has arrested development of this concept in China so far. No commercial entity has proved willing or able to incur these upfront development costs. While the Government has expressed a strong commitment to the project, evident in its financial support, the Government also has been clear that it cannot sanction borrowing of IBRD or commercial bank funds for initial development and demonstration of the energy performance contracting concept, which is commercially unproven in China. GEF Project Development Fund (PDF) support has played a role in the necessary upfront technical assistance. The EC Grant has been critical, to allow some initial experience to be gained in implementation of a small number of pilot projects prior to GEF and IBRD project approval. GEF support, blended with Government counterpart financing, is critical for demonstration of the energy performance contracting concept in the three EMCs, development and adaptation of the new information dissemination methods and practices, and the institution building necessary to sustain these activities. Follow-up GEF support, through the proposed Phase II EMC Expansion, will also be necessary to overcome barriers to further EMC development throughout China. The IBRD loan also is an essential part of the package, as it provides much of the loan capital for the EMCs to develop and grow as commercial businesses. The loan will be onlent to the EMCs on commercial terms, and successful EMC growth under market conditions will provide the best demonstration of the concept's viability to domestic commercial banks. E: Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (supported by Annex 4): [ ] Cost-Benefit Analysis: NPV=US$ million; ERR= % []Cost Effectiveness Analysis: [X] Other (Specify) Project justification and economic analysis are discussed in detail in Annex 4. The economic analysis for the demonstration phase of the EMCs, financed in part with EC and GEF grants, and the information component, were based on the global environmental incremental cost methodology of GEF. The incremental cost of the EMC component has been calculated as the difference between what would have been spent on industrial energy conservation in the three pilot provinces (the "baseline"), and the amount needed to overcome the barriers to the establishment of a market-based ESCO program in these provinces (the "GEF alternative"). The cost to GEF for direct carbon reduction under the EMC and information program components is about 40-60 US cents per ton of carbon, which compares very favorably to GEF investments in other countries. The EC and GEF pilot-phase investments are essential for commercial replicability of the EMC component, to be supported by IBRD and domestic commercial loans. No ESCOs have been developed in China, and commercial entities have been so far unwilling to undertake the risk to introduce and demonstrate the concept. Once the concept is developed and adapted to Chinese conditions, economic returns are projected to be high, which will promote replicability. The economic rate of return of the investments to be supported under the IBRD loan are estimated to be about 47 percent, shared between the EMCs and the host enterprises. Financial rates of return to the EMCs for Page 12 the same investments are in the range of 20 to 25 percent. The present value of the total net economic benefits of the EMC Demonstration Component is estimated at about US$325 million. 2. Financial analysis: A discussion of financial issues and detailed analysis are presented in Annex 5. The Bank and PMO conducted a financial appraisal of the three EMCs, based on their I 0-year business plans. The EMCs are in many ways a unique type of business, combining aspects of an industrial enterprise with aspects of a bank or leasing company. In addition to needs to continually refine their business strategies to minimize risk and maximize profits, the EMCs must carefully control indebtedness, maintain a conservative debt- to-equity ratio, and keep strict control of accounts receivable. The Bank has obtained assurances in these areas. For all energy performance contract projects supported with EC, GEF or IBRD financing, host enterprises will be required to meet specified financial criteria (see Annex 3). In addition, further intensive technical assistance is being provided to the EMCs in corporate financial management for ESCOs under the EC Grant, and further follow-up will be undertaken under the Program Management and Monitoring Component. The project as a whole has a large positive fiscal impact, stemming from tax receipts (VAT, import duties, sales tax and EMC income tax) from the EMC businesses. 3. Technical analysis: Technical aspects of initial EMC energy performance contract projects are being reviewed by international consultants engaged by the Bank and PMO. EC-financed projects are being individually reviewed. GEF and IBRD-financed projects also will be individually reviewed until the Bank waives this prior review requirement for specified project lines in specified EMCs. Further details are presented in Annex 3. 4. Institutional: Institutional development is a core objective of this project, and the three demonstration EMCs and Energy Conservation Information Dissemination Center will be new institutions. Institutional arrangements and issues are described in Annex 3. 5. Social: The project entails no resettlement or land acquisition, and no social development issues. 6. Environmental assessment: (Category B) This project will result in substantial environmental improvements through increased energy efficiency. Negative environmental impacts are not expected. The EMCs will be involved in hundreds of small subprojects, which will be identified during project implementation. Few, if any, will involve any negative environmental or safety issues. These projects generally involve replacement of standard types of equipment (motors, fans, pumps, lamps) or addition of energy-saving devices. The Environmental Protection Bureaus of Beijing Municipality, Liaoning Province and Shandong Province have each evaluated the prospective project lines of the relevant EMCs, and formally endorsed and approved the business plans of the three EMCs for implementation. In addition, assurances were obtained from the EMCs at negotiations that they will identify any subprojects with potential negative environmental or safety impacts and, in such cases, provide the Bank with a plan for subproject implementation that will mitigate those impacts and confirmation of necessary government approvals. Page 13 7. Participatory approach: The primary beneficiaries of the project-Chinese enterprises-have been closely involved in project development and initial implementation through the EC Grant, and will be critical partners throughout implementation. It is the nature of the business of EMCs to develop joint implementation arrangements for energy conservation projects with host enterprises. As core aspects of their business, the EMCs supported under the project have completed, and must continue, assessments of enterprise needs and demands, joint identification of investment opportunities, and negotiation of mutually beneficial implementation arrangements. Other key stakeholders include the variety of Chinese groups of which the country's energy conservation network is comprised, including agencies and public companies associated with the SETC and State Planning Commission at central, provincial and local levels; units associated with the China Energy Conservation Association; regional and local power companies; academic and research organizations; and local energy conservation technical service units. Representatives of these groups have been active as members or advisors to SETC's PMO and/or the provincial-level PMOs for this project, and the advice of these groups has been sought by the project leaders at central and provincial levels through a number of workshops and work conferences. The introduction of the EMC concept has attracted great interest in China's energy conservation community, and the combination of information dissemination and seeking of advice between the PMOs and the wider network begun during project preparation will continue with support under the Program Management and Monitoring Component. This project has generated interest in the international energy efficiency community as well. In addition to staff from the GEF and EC, the Bank and/or Chinese project teams have consulted with representatives of other multilateral institutions (e.g., UNDP, ADB and EBRD), a number of bilateral donor agencies, international research institutes and academic organizations, NGOs active in energy efficiency work, and a range of international ESCOs. These consultations have yielded useful advice for the project team, incorporated in the project design, and also helped spark interest in applying some of the concepts of this project in other countries. F: Sustainability and Risks 1. Sustainability: Project sustainability is enhanced by strong project ownership by the beneficiaries, and a focus on adaptation and revision of the new concepts by the counterparts to match Chinese circumstances. Domestic commercial bank financing for EMCs is important for sustainability after project implementation. Accordingly, the Provincial Governments have involved several domestic banks in project preparation activities, and conferences and workshops to introduce the initial results of the three demonstrations EMCs and energy performance contracting concepts to the domestic financial and banking community, once some experience has been gained, are included in the project. 2. Critical Risks (reflecting assumptions in the fourth column ofAnnex 1): This project involves high initial costs to develop and adapt the energy performance contracting concept to Chinese conditions, through a series of technical assistance, pilot demonstration, monitoring and evaluation and correction activities, begun during project preparation and accelerated during the first years of project implementation. Without separate, concessional EC and GEF financing of these costs, the proposed Bank loan would clearly be too risky and not financially prudent. Government agencies, taxation and legal authorities, the Chinese financial community, and potential client or host enterprises Page 14 are unfamiliar with the concept. Some issues can (and are) being overcome through technical assistance in project preparation and implementation. However, initial, on-the-ground experience in energy performance contracting is required, including adaptation for different types of technologies, customer groups and contractual arrangements, as each involves significantly different issues. While there is little debate in China or abroad that the energy performnance contracting concept has great potential in China, no party has been willing to shoulder the high initial development costs. Once the initial barrier is overcome, the project is designed to capitalize and build upon the experience gained through (a) IBRD credit on commercial terms for replication of proven project packages in the three EMCs, and hence EMC growth, and (b) the Phase II EMC Expansion effort, to support the development of a variety of other types of EMCs, including joint-venture and private sector firms. Overall risks associated with the EC/GEF/SETC-financed EMC demonstration projects are rated medium. Risks of individual performance contract project failure include risks of technical failure, inability to enforce contracts, and lack of financial performance. These risks are being minimized by emphasis in project selection on (a) simple, proven technology, (b) projects where energy savings monitoring and verification are relatively simple, (c) projects with rapid payback periods, and (d) selection of host enterprises which are particularly keen and competent. The existing active involvement of the SETC and especially provincial Economic and Trade Commiissions also is critical during this trial period to coordinate adaptation to the existing legal, taxation and institutional management framework, and to assist in minimizing risks of contract defaults. Overall risks associated with the IBRD loan are rated moderate, as use of loan funds will be targeted towards technology/contract/consumer group packages which are proven to hold the greatest promise for growth. 3. Possible ControversialAspects: This project has a low controversial issues rating for all categories (social, ecological, pollution, governance). G: Main Loan Conditions 1. Effectiveness Conditions: No critical policy or institutional reforms have been sought. Execution of onlending and subgrant agreements for the EMC Demonstration Component satisfactory to the Bank are conditions of GEF Grant and IBRD loan effectiveness. 2. Other [classify according to covenant types used in the Legal Agreements.]: Assurances were obtained at negotiations in the GEF Grant, IBRD Loan and Project Agreements that the Grant Recipient, Loan Borrower and Project Beneficiaries will prepare mid-term project review reports, based on terms of reference satisfactory to the Bank, by August 31, 2000 and August 31, 2002, review them with the Bank by September 30, 2000 and September 30, 2002, and take necessary measures based on the report recommendations and the Bank's views. Assurances were obtained at negotiations in the GEF Grant and IBRD Loan Agreement that the Recipient will, through SETC: Page 15 * enter into a performance contract satisfactory to the Bank with the Energy Conservation Information Dissemination Center by June 30, 1998, or a later date agreed with the Bank; * maintain the PMO, comprised of a project management unit and an EMC development unit, both with functions and resources acceptable to the Bank and competent staff in adequate numbers, to coordinate project implementation; and * ensure that ECIDC shall be maintained with qualified and experienced management and competent staff in adequate numbers, and that ECIDC shall implement a time-bound project implementation and staffing plan and long-term financial plan, both satisfactory to the Bank. Financial assurances obtained at negotiations in the EMC Project Agreements include assurances that each EMC will: * not incur any further indebtedness unless its net revenues exceed, and are projected to continue exceeding, its debt service obligations by at least 1.6 times; * adopt and maintain a conservative capital structure and dividend policy throughout the duration of the loan such that total long term debt will not exceed 60 percent of total capitalization (net equity + total debt); * undertaken all projects on acceptable commercial terms and ensure that the average collection period of all accounts receivable does not exceed 60 days; and * provide the Bank, by end-March of each year, with a rolling five-year financial plan containing the investment program, business plan and projected financial statements; and taking into account the Bank's comments implement the plan thereafter. Special subproject implementation assurances obtained at negotiations in the EMC Project Agreements include assurances that each EMC will: * identify six or more types of subprojects (product lines) and implement one or more pilot projects within each; * enter into energy performance contracts for these projects, which protect specified interests of the Bank, Borrower and EMCs, and which shall be on commercial terms and for subprojects that meet criteria acceptable to the Bank (as described further in Annex 3, Section A); * obtain Bank approval for all individual energy performance contracts to be financed with GEF or IBRD funds prior to execution, until and unless the PMO and Bank formally waive this prior review requirement for the relevant project line of the relevant EMC; and * identify any subprojects with potential negative environmental or safety impacts and, in such cases, provide the Bank with a plan for subproject implementation that will mitigate these impacts and confirmation of necessary government approvals. Execution of a performance contract between SETC and ECIDC satisfactory to the Bank will be a condition of disbursement of Part B (the information dissemination component) of the GEF grant. H. Readiness for Implementation [ ] The engineering design documents for the first year's activities are complete and ready for the start of project implementation. [x] Not applicable. [ ] The procurement documents for the first year's activities are complete and ready for the start of project implementation. [x] The Project Implementation Plan has been appraised and found to be realistic and of satisfactory quality. Page 16 I. Compliance with Bank Policies [x] This project complies with all applicable Bank policies. [signature] .. R fE Task Team Leader/Task Manager: Robert P. Taylor .;- ..- --_ [signature] Sector Manager/Director: Yoshihiko Sumi rsignlattu Country Manager/Director: Yukon Huang Page 17 ANNEX 1 ANNEX 1: PROJECT DESIGN SUMMARY Narrative Summary Key Performance Indicators /a Monitoring and Supervision Critical Assumptions and Risks (a) CAS Objective (CAS and GEF Objectives to Alleviate infrastructure con- See below See below Bank Mission) straints; safeguard the environ- Increases in energy efficiency ment provide increases in energy (b) GEF Operational services without negative Program Goal: OP#5 environmental impact. Project Development and (Development and Global Global Objectives Objectives to CAS Objective) Achieve large, sustained and Quantified energy savings per Biannual project summaries Energy efficiency gains are growing increases in energy year, and associated CO2 prepared by the PMO integrat- sustained and grow from (a) efficiency, and associated emissions reduction resulting ing and summarizing data proliferation of energy per- carbon dioxide emission reduc- from the project. described below. formance contracting concept, tions with (a) new project and (b) sustained operation of financing concepts and market- instituting developed under the oriented institutions; and (b) project (three EMCs, national improved access to information information center). on successful, financially attractive energy efficiency experiences. (Outputs to Development and Project Outputs Global Objectives) * Development, demonstration * Quantified energy savings * Project implementation and EC/GEF/SETC financing of and growth of energy and CO2 reduction from energy savings data in initial development costs is performance contracting in projects of three EMCs. project reports from three required. Without this finan- three demonstration EMCs. EMCs. cing, IBRD loan risks are unacceptably high (see PCD text for details). * Proliferation of energy * Listing of firms engaged in * Results of monitoring survey performance contracting to a energy performance continu- of SETC on energy perform- variety of companies in ity in China and estimated ance contracting in China at China. energy savings and CO2 large. reductions from their activities. * Increased adoption of key * Energy savings and CO2 * performance reports of infor- energy efficiency measures reductions from energy effi- mation center, required in due to improved access to ciency measures of enter- performance contract with high quality, financially prises verified to be a result SETC, following methodol- relevant information. of specific information ogy used in the United discussed by the energy Kingdom. efficiency information center supported by the project. Project Components * EMC Demonstration Standard project Project progress and See above. * Information Dissemination implementation indicators. supervision reports. * Technical Assistance L/ See section below. Page 18 ANNEX I Key Performance Indicators and Monitoring Methods The key indicators of success in achieving project development objects are the energy savings achieved per year and associated reductions in the growth of carbon dioxide emissions. Performance indicators for the core EMC Demonstration Component, which accounts for 92 percent of the project investment by GEF and IBRD, are provided below. These performance indicators include only a portion of the direct energy savings expected from the investments of the three demonstration EMCs. (Total direct energy savings from the three EMCs are estimated at 45 million tons of coal equivalent, and associated total carbon dioxide emissions reduction is estimated at 34 million tons carbon.) The indicators include only savings achieved during the project implementation period, whereas large additional savings are expected after the project is completed from continued savings from investments undertaken during the project implementation period. Furthermore, the performance indicators are somewhat more conservative than the energy savings estimates corresponding with the business plans of the three EMCs, incorporating greater risk of implementation difficulties than the company targets. Energy savings figures include savings resulting from EC-supported pilot projects. Performance Indicators for Energy Savings and Reduction of Carbon Dioxide Emissions from Direct Investments of the EMCs Calendar Years Total 1998 1999 2000 2001 2002 2003 2004 2005 2006 Period Energy savings 0.04 0.2 0.5 0.8 1.3 1.7 2.1 2.8 3.6 13.0 (million tce) Carbon reduction 0.03 0.1 0.3 0.5 0.9 1.2 1.5 1.9 2.5 9.2 (million t) Total actual energy savings and associated carbon dioxide emissions reductions achieved from all subprojects will be reported by each EMC in their annual project reports (as well as more frequent project updates, as and when required). Actual energy savings for each of the energy performance contracts of the EMCs are relatively easy to monitor during the implementation of the energy performance contracts, as measurement or confirmation of stipulated energy savings are key aspects of these contracts. To assess energy savings from projects after contract periods are over, the EMCs will complete sample surveys of sufficient size and using internationally accepted scientific sampling and statistical methods to ensure the reliability of results. Final annual energy savings and associated carbon dioxide reduction indicators for the information dissemination component will be included in the performance contract between SETC and ECIDC, to be completed by June 30, 1998, following completion of ECUDC's detailed project implementation plan. Energy savings eventually resulting from this component may total 24 million tce, and associated carbon dioxide emissions reductions may total 18 million tons carbon, but as in the case of the EMC Demonstration Component, only a portion will be achieved during the project implementation period. Estimation of energy savings actually achieved in this case is complicated and difficult, but the necessary survey work is also required for ECIDC to continually monitor and adjust its marketing methods. Monitoring will need to involve at least three components: (a) compilation of data on the number of types of energy conservation investments promoted and the typical energy savings which may be achieved, largely from the number of successful case studies and technical guides prepared each year; Page 19 ANNEX I (b) data on the number of enterprise managers contacted directly and indirectly, and the number of enterprise managers that have actually reviewed the specific information provided; and (c) the number of enterprise contacts that have resulted in implementation of the energy conservation measures being promoted. It also may be useful to survey the recorded sales of the energy efficiency technology being marketed by ECIDC as another source of information. Even though specific performance indicators are not necessary, measures of the success being achieved by the EMC Development Unit also should be monitored and reported at least biannually, and should include : (a) data on the detailed activities of the unit, including requests for assistance received and acted upon, contacts made, marketing activities conducted, etc., and (b) data on the number of enterprises utilizing energy performance contracting in China, the scale of the investment portfolio of these enterprises, and estimates of the energy savings being achieved by these firms. For each of the three EMCs, additional financial project implementation performance indicators includes: (a) maintenance of accounts receivable of 60 days or less in each year of project implementation, and (b) achievement of a return on assets of at least 6 percent in 1999, and 9 percent in 2002 and 2006. Page 20 ANNEX 2 ANNEX 2: ENERGY CONSERVATION IN CHINA: MAKING THE TRANSITION TO THE MARKET ENERGY CONSUMPTION-INTENSITY In 1990, China's economy was among the most energy-intensive in the world, registering an energy use per unit of GDP level some 3-10 times that of major developed countries. One of the reasons for China's high energy intensity is that industry comprises about 44 percent of China's GDP (1993), a share much higher than that of other low-income countries and even higher than Japan. This drives up energy intensity because industry is far more energy-intensive than the other major sectors. Chinese industry has also been dominated by the production of basic, intermediate industrial goods, and generally low levels of product quality or specialization, while out-of-date, energy ineiFficient technology remains pervasive throughout Chinese industry. China's commercial energy intensity per unit GDP fell by over 30 percent between 1980 and 1990-a remarkable achieve by internationai standards. The elasticity of growth in commercial energy use relative to GDP growth was just 0.5 percent. Among the largest energy-intensive industries, the most impressive gains were made in the steel industry, where unit energy consumption fell by over 20 percent between 1980 and 1990. One of the factors behind the drop in industrial energy intensity since 1980 has been the increasing share of relatively less energy-intensive subsectors, such as machinery and electronics industries, and declining roles of the energy-intensive metallurgy and chemical fertilizer industries. Even more important has been a shift in the mix of products produced within industrial subsectors (e.g., within the chemical industry itself), and this trend is expected to continue. In the textile and garment industry, for example, a substantial growth in value-added is not expected to come from huge increases in square yards of cloth or numbers of shirts produced, but more from increases in product value, in terms of quality and fashion. Declines in energy use per unit of output value due to this trend will be especially important in the chemical, machinery, building materials and light industry sectors, which together accounted for over 60 percent of industrial final energy use in 1990. Although structural effects may have the greatest impact on the energy intensity of China's economy, technical efficiency levels-energy consumption per physical unit of output-can be more directly influenced by national and local policies. Unlike many other GHG reduction options, emissions reductions from technical energy efficiency improvements can be realized almost inmnediately. Because Chinese industry will undergo dramatic transformation as a result of economic growth, the opportunities for energy efficiency gains are greatest between now and the year 2010. ENERGY CONSERVATION POTENTIAL There is tremendous scope in China for further improvement in the technical efficiency of energy use (e.g., the efficiency of energy use per physical unit of output). By far the largest potential for technical efficiency improvement in China is in the industrial sector, where potential energy savings between now and 2020 are more than 500 million tons of coal equivalent (Mtce) per year, or more than half of China's current annual energy consumption. Among the industrial energy conservation projects which have been identified as having great potential in China include: waste heat, gas, and resource recovery; Page 21 ANNEX 2 cogeneration; adoption of more electric-motor drive systems; furnace and kiln renovation; improvements in industrial boiler efficiency; improved energy management systems; and insulation and thermal/steam system renovation. A second area of energy conservation potential is in commercial and residential buildings, for lighting, water heating, and space heating and cooling. At least 100 Mtce can be saved over the next 20 years through energy conservation investments in buildings, where a large amount of new construction will take place. CHINA'S ENERGY CONSERVATION PROGRAM China's energy conservation system is among the most extensive in the world. During the 1980s, China successfully developed a comprehensive energy conservation program, including major policy directives, procedures, regulations, technical assistance programs, and project financing initiatives. Compared to programs in other developing countries, China's program is especially strong in its comprehensive coverage of enterprises, monitoring of consumption practices, promotion of awareness of energy efficiency goals among enterprise managers, and domestic technical information dissemination. Built largely around the planned economy, the system developed during the 1980s emphasizes administrative measures to prod enterprises to improve energy efficiency. A drawback with planned economy measures is that they are not automatic or built into the economic system. Administration is usual difficult and complicated. The pressure applied to enterprises is greatly uneven, and for reasons that are arbitrary from an economic point-of-view. In addition, the planned economy system encourages mediocrity, rather than promotion of optimal efficiency levels, as performance evaluation tends to be referenced against domestic averages. The institutional framework for energy conservation in China includes a number of specialized energy conservation units at national, provincial and county/municipal levels, operating under the State Economic and Trade Commission (SETC), and provincial and local Economic Committees. National plans and capital construction projects to improve energy efficiency are undertaken by the State Planning Commission (SPC) and its affiliates at provincial and local levels. The China Energy Conservation Investment Corporation handles much of the capital construction project investment, with the general guidance of SPC. The system was quite effective under the centrally planned economic system, taking advantage of the well-established framework of industrial enterprise energy input quotas and government investment funding mechanisms for investment in state-owned enterprises. Central and provincial electricity administrations coordinate conservation work at the local level through the Offices of Electricity Allocation, Conservation, and Safety. A number of provinces have established energy conservation service centers to provide enterprises with technical advice and training. Most of these centers have concentrated on measurement and monitoring of energy use, especially to check compliance with energy consumption quotas and standards. With the ongoing conversion of China's economic system to a market economy, the system for promoting energy conservation must be transformed to operate more effectively in a market economy. Many of the administrative measures which have been relied on in the past cannot be expected to work effectively or efficiently in a more market-oriented future. Nonetheless, much of the energy conservation promotion system built up through the 1980s can serve China well in the future; the institutional network, and its increasing capacity to execute serious energy conservation initiatives on a comprehensive scale, provide a critical advantage. A broad set of reforms are underway in China providing state-owned enterprises with autonomy and full accountability for profits and losses, with new fiscal and tax provisions enforcing budget constraints and accelerating corporatization. Efforts to promote energy efficiency must now be built primarily on the self-interest of enterprises, as a means to Page 22 ANNEX 2 increase enterprise profits and/or to meet environmental regullations. New and different financing approaches and mechanisms are also needed. BARRIERS TO ENERGY CONSERVATION IN CHINA'S TRANSITIONAL ECONOMY There are a wide variety of constraints impeding implementation of attractive energy conservation projects in China. Some constraints to energy conservation projects are because of the current transition from a planned to a market economy, while others are common in (leveloped market economies as well: * Weak Cost-consciousness. "Classic" energy conservation projects involve upfront investments- to reduce future energy operating costs. Enterprise enthusiasm for such investments require strong desire by enterprise management to control operating costs as a means to increase enterprise profits. While the profit motive and market competition are rapidly increasing cost-consciousness in Chinese enterprises, it takes time for management methods and attitudes to change. * Demand for Short Payback Periods. People with experience in the promotion of "classic" energy conservation projects know that these investments are alrnost always assessed by enterprise managers or potential investors in terms of their payback period, rather than their life-cycle rate of return. Conservation investments with payback periods of more than five years are rarely undertaken by enterprises or investors, unless there are other pressures. - Risk and Uncertainty. Use of payback period calculations are usually associated with risk and uncertainty. Whereas investments in output expansion involve physical, easily perceived benefits, the benefits from energy-saving investments are future cost savings calculated by analysts. In China, a bias against cutting operating costs has been exacerbated by a management culture attuned to maximizing physical output and achieving-or surpassing-output quotas. Another category of risk is market and technical risk stemming from the current rapid change in China's economy. The increasing role of competition and the market is driving a major economic restructuring, and associated volatility in the profitability of different sectors and product lines. In China today, flexibility to respond to rapid market changes is critical. Long payback periods mean funds are tied up. Not only may future opportunities for high-return profits be foregone, but market changes may render renovated production lines, although more energy-efficient, less profitable or unprofitable as a whole. * Lack of Adequate Information. Often, viable energy conservation investments may not be undertaken because enterprise managers have limited knowledge of these opportunities. Particularly lacking is practical information on actual enterprise experiences with different technical measures, and the details of the actual cost savings and increased profits. * Low Financial Significance and Transaction Costs. Even if rates of return are high, and payback periods are considered acceptable, many energy conservation projects may not be considered priority investments by enterprises because net benefits are not large relative to the size of the enterprise. The time and effort of staff to gather information, design projects, undertake the relevant analysis, and implement the projects may not be worthwhile. In other words, there may be a number of additional, hidden costs involved in project preparation and implementation, especially for highly valued staff, which reduces the project's attractiveness. * Lack of Financing. For some energy conservation projects, enterprises lack adequate funds for investment. A more common financing problem is that domestic banks do not wish to lend for energy conservation projects as they do not directly result in increased production. Page 23 ANNEX 2 WHAT IS ENERGY PERFORMANCE CONTRACTING? Energy performance contracting is a means to pay the entire cost of an energy conservation project out of reduced energy expenditures. The energy savings that result from the energy efficiency investment are used to finance the project. Such a mechanism allows customers to use future energy savings to upgrade plant and equipment and to cut operating costs now. Energy performance contracts, signed between enterprises undertaking energy efficiency investments (the "host" enterprise, or the "customer") and specialized profit-seeking energy management companies, can help promote energy efficiency projects. Under other, traditional arrangements, all of the risk and all of the benefits of energy efficiency projects lie with the enterprise undertaking the investment. Consequently, many promising energy efficiency investments have yet to be implemented. There are several steps in the identification and implementation of energy performance contracts by energy management companies (EMCs): * Identification and Selection. A company (usually the EMC) does an assessment of the customers' opportunities for cost-effective energy efficiency measures. The current energy use of the customer may be measured, along with the anticipated savings from various energy efficiency improvements. Typically the EMC or their contractor design the efficiency improvements. * Financing and Payments. The EMC uses their capital (or that of a third party, such as a commercial bank or equipment supplier) to finance the capital investment. The customer and the EMC negotiate a deal to allocate cost and savings from energy conservation investments over a period of time. The EMC and the customer share the energy savings on a agreed split. The usual energy performance contract provides the EMC with most of the savings during the early years of the contract to repay the capital investment, while the customer's share of the savings rises in later years. Payment is made by the customer to the EMC based upon an agreed schedule. In some countries, the EMC may take over payment of the energy bills for the term of the agreement in return for a fixed payment from the enterprise. The enterprises' payments for energy use and a portion of the conservation investment should be equal to or less than previous energy bills; the energy savings are thus used to finance the capital investment. * EMC structure. EMCs can take many forms. Some have evolved from engineering companies into energy management firms providing energy efficiency services. Others have evolved from energy management equipment manufacturers seeking greater markets for their products. In the past 10 years in the United States, EMCs associated with electric power companies have flourished. Power companies have formed subsidiary units to provide energy efficiency services to their customers initially and then to others. Other power companies have hired independent EMCs to provide energy efficiency services to their customers. A recent trend has been power companies acquiring EMCs to provide services to their customers and those of other power companies. Producers of high energy efficiency equipment also have a clear commercial incentive to establish EMCs. HOW CAN ENERGY PERFORMANCE CONTRACTING HELP OVERCOME BARRIERS TO ENERGY CONSERVATION IN CHINA? The objective of "energy performance contracting" in China is to accelerate energy conservation and efficiency investments by removing two major barriers: (1) inadequate financial incentives, and (2) a lack of capital for project financing. While high transactions costs and "insignificance" are major barriers to many energy efficiency investments in China, they reflect enormous market potential for energy performance contracting. Much Page 24 ANNEX 2 of the potential for energy savings in China is through implementation of large numbers of individually small projects. High transaction costs to individual enterprises are also a barrier to undertaking energy efficiency investments. Energy efficiency projects often carry high costs (particularly high opportunity costs of key skilled enterprise personnel) for obtaining and checking information, planning and design, arranging financing, implementation scheduling, monitoring initial performance and implementing necessary adjustments. EMCs can reduce the high transactions costs to individual enterprises by undertaking the relatively small energy conservation investmenjts and providing a low-risk guarantee to host enterprises. Energy performance contracting can help overcome financing problems and allow host enterprises to undertake energy conservation investments with little or no investment of their own. And, because these are not loans to the host enterprise, and payments to the EMCs are typically paid from reductions in operating costs, no debt for the investment is carried on the books of the host enterprise. Page 25 ANNEX 3 ANNEX 3: PROJECT DESCRIPTION AND COSTS A. EMC DEMONSTRATION COMPONENT Concept and Activities Under the Energy Management Company (EMC) Demonstration Component, energy performance contracting will be introduced and developed in China through the establishment, development, operation and expansion of three EMCs, in Liaoning Province, Shandong Province, and Beijing Municipality.) Including technical assistance during project preparation, the component involves four phases: (a) training and technical assistance on energy performance contracting concepts, establishment of the EMCs, and initial project preparation (GEF PDF-financed, 1996-97); (b) intensive training and technical assistance on EMC operations and implementation of the first pilot projects by the EMCs (EC- financed, 1997-98); (c) implementation of a wide variety of demonstration projects (GEF/counterpart fund-financed, 1998-2000); and (d) EMC growth, through replication of successful demonstration projects (IBRD/counterpart fund-financed, 1998-2003). Initial project preparation activities. Following introduction by international advisors of basic energy performance contracting concepts and a competitive process undertaken by SETC to select provinces to participate in the project, Liaoning, Shandong and Beijing EMCs were first established in April 1996. Subsequent major activities included (a) an assessment of international experiences in energy performance contracting by the PMO and three EMCs; (b) preparation of first-draft EMC business plans, including project development and scheduling, and corporate finance, with substantial international expert assistance; and (c) initial training in project design, verification of energy savings and development of contract models appropriate for Chinese conditions, through preparation of initial energy performance contracting pilot projects with international advisors. EC Grant. Approved by the European Commission in December 1996 and made effective in June 1997, an EC grant of ECU 4 million (about US$4.5 million) is providing funding support to begin initial EMC operations prior to GEF grant and IBRD loan approval and effectiveness. An average of US$ 1.1 million is being provided to each EMC to support some 8-12 energy performance contracting pilot projects each, and to sum up experiences. The pilot projects are being approved in three phases during 1997 and early 1998, with staggered implementation through 1997 and 1998. As the first energy performance contracting projects in China, each project is being reviewed by the PMO and Bank team together with the EMCs, and revised if necessary, prior to approval. By January 1998, the first phase of projects were under implementation with initial favorable results. Technical assistance and training during the last half of 1997 and early 1998 supported by the grant include: (a) development of customized training materials, curriculum and course delivery of a major two-part course for EMC project managers on the technical and commercial aspects of energy performance contracting; (b) technical assistance on EMC financial management and development of relevant procedures and MIS; (c) education of government policy officials and provincial government staff on energy performance contracting; (d) engagement of short- term international and domestic advisors for the PMO and EMCs on selected topics; and (e) evaluation of project progress by late 1998 by an independent, third party. l Energy performance contracting is described in Annex 2. Page 26 ANNEX 3 GEF Pilot Projects. Each EMC has identified 6-10 potential "project lines" for their energy performance contracting businesses in the coming years. Under the EC Grant, a few pilot projects within several of the project lines will be implemented by each. Subsequent GEF financing averaging about US$5 million for each EMC would support implementation of pilot projects among all of the project lines. Moreover, several pilot projects will be developed within each project line, with substantial adjustments in the energy performance contracting mechanism to meet the requirements of different types of enterprises and to adapt different variations in savings verification or contractual arrangements. EC and GEF pilot project implementation will be undertaken over a four-year period, enabling the EMCs to develop project lines gradually, as company capabilities and expertise allow, and with sufficient flexibility to try new concepts, savings verification arrangements and contractual terms, based on the experiences previously gained. Project Replication and EMC Growth. The proposed IBRD, domestic counterpart loans, reinvested profits, and, increasingly, domestic commercial loans arranged by the EMCs will provide the capital for replication of successful pilot projects on a large scale and EMC ,growth. EMC business success will require translation of the successful experiences, expertise and market credibility gained from the pilot projects in a given project line into the development of a "mass production" project line, using tested project designs, savings verification and contractual arrangements for large numbers of projects, with declining transaction costs and risks to the EMC. Implementation of "replication" projects using loan capital within successful project lines developed in 1997 and 1998 will overlap with implementation of pilot projects in other, newer project lines during the initial years of project implementation. EMC Investments and Financing. Annex 5 provides an assessment of the investment plan, financing plan and financial position and projects of the three EMCs. EMC Institutional and Legal Structure The three EMCs are for-profit limited liability shareholding companies, established and registered in 1996 according to China's Company Law. Following a prevailing model in modern China, the company shareholders are public entities or publicly owned corporations, but the EMC are autonomous from the government, with independent accounting, independent management, and sole responsibility for their profits and losses. Company management reports to a Board of Directors, representing the company shareholders. The official names and shareholders of the EMCs are: C Liaoning Province Energy Conservation Technology Development Company, Ltd. Registered capital at inception totaled 20 million yuan, with shareholders including Liaoning Provincial Electric Power Development Company (50 percent), Fushun Aluminum Factory (25 percent), Liaoning Xinda Industry Development Company (10 percent), Liaoning Province Energy Conservation Center (5 percent), Liaoning Province Magnesium Resource Protection Office (5 percent), Shenyang Yukai Science and Technology Development Co. (5 percent). * Shandong Energy Conservation Engineering Company, Ltd. Registered capital at inception totaled 34.4 million yuan, with shareholders including Shandong Energy Conservation Technology and Service Company (wholly owned by the Shandong Provincial Economic and Trade Commission) (58 percent), Shandong Energy Savings and Technical Service Center (24 percent), Shandong Shengli Stock Corporation (15 percent), and Sanlian Group Corporation (3 percent). The EMC Board of Directors also would like to accept new shareholders, perhaps expanding the registered capital to a total of more 60 million yuan by the end of 1999, with the new shareholders, provisionally including Shengli Oil Administration Bureau, Shandong Provincial Electric Power Company and Shandong Yanzhou Coal Administration, each providing about 10 million yuan. With the addition of these Page 27 ANNEX 3 shareholders, the largest shareholder's share (Shandong Energy Conservation Technology and Service Co.) will fall to under 50 percent. Beijing Yuanshen Energy Saving Technology Company, Ltd. Registered capital at inception totaled 20 million yuan, with shareholders including Beijing Energy Investment Company (affiliated with the North China Power Group, 75 percent), Beijing Energy Savings Monitoring Center (15 percent), and Beijing Energy Savings Technical Service Center (10 percent). The energy efficient lighting projects of the EMC are being implemented in association with Beijing Sanyuan Green Lighting Technology Development Co., in which Beijing Yuanshen Energy Saving Technology Company holds a controlling share of 60 percent of that company's registered capital of 500,000 yuan. Electric power utilities are the dominant shareholders in the Liaoning and Beijing EMCs, and a power company is expected to become a minority shareholder in the Shandong EMC in 1998. Provincial Energy Conservation Centers, established in the 1980s and supervised by the State and Provincial Economic and Trade Commissions, are small shareholders in each EMC, and a significant number of the technical staff in the EMCs has transferred from these Centers. While there are some variations in internal organization, a strong financial management department and one or several strong operational departments are common features in each EMC. As of Fall 1997, core staff in each EMC included about 8-10 professionals, plus a number of contracted advisors and senior technicians. Each EMC has established recruitment plans, criteria and procedures for steady increases in staff as the number of projects undertaken by the companies increase. Training of new EMC project managers is a high priority, and hence substantial investments are being made under the EC Grant to develop an in-depth, practical training course which can be delivered biannually for project managers. Development and installation of a financial management, reporting and billing system to meet the special needs of the EMCs also is a high priority, and will be supported with EC and GEF financing. EMC Project Lines Each EMC has planned its business to include a series of project lines, as illustrated in Table 1. These business plans will change as experience is gained and market opportunities develop or contract-the business plans presented should be revised in a flexible manner at least annually as project implementation proceeds. After the initial startup and phased growth, each EMC is expected to eventually develop and implement 80-100 new projects per year. The average project investment cost during the initial years is about 1.6 million yuan (about US$200,000), rising to about 2.6 million yuan (about US$3 10,000) in the later years. Each of the three EMCs has developed their project lines in accordance with the conditions in their provinces and their particular staff expertise, but as the three have exchanged ideas, there has been considerable cross-fertilization. Compared to ESCOs in Canada and the USA, the Chinese EMCs are adapting energy performance contracting with a greater focus on industrial applications, and have developed a number of project concepts which have big market potential in China today but would not have a significant market in the West. Each of the project lines is being reviewed as the EMCs prepare the relevant initial demonstration projects for PMO and Bank review and approval. As a result, project lines with demonstration projects financed by the EC or proposed for funding during the first year of GEF fund disbursement had been more thoroughly reviewed by the time of project appraisal, while other project concepts will be more fully reviewed during project implementation. All three of the EMCs are developing early project lines for installation of energy efficient lighting in commercial and public buildings, installation of more energy efficient electric motor systems, and renovation of small and Page 28 ANNEX 3 TABLE 1: PLANNED PROJECT LINES OF THE THREE EMCs, OCTOBER 1997 Number of Projects Investment (Million Yuan) 1997-99 2000-06 Total 1997-99 2000-06 Total Liaoning EMC Electric furnace renovations 33 113 146 88 387 475 Efficient electric motor drives 15 131 146 42 457 499 Boiler renovations 29 140 169 24 144 168 Efficient electric lighting 20 87 107 9 55 64 Steam & air hammer replacement 5 72 77 12 227 239 Waste heat recovery 1 54 55 3 246 249 Other 0 38 38 0 424 424 Total 103 635 738 178 1,940 2,118 Shandong EMC Commercial building lighting & pumps 15 13 28 16 17 33 Autoclave insulation 11 68 79 25 205 230 Steam & air hammer replacement 12 6 18 9 4 13 Efficient electric motor drives 24 144 168 55 421 476 Boiler renovations 25 62 87 11 31 42 Electric arc furnace renovations 4 9 13 9 23 32 Waste heat recovery 4 82 86 7 187 194 Waste heat power generation 4 70 74 16 345 361 Glass furnace insulation 4 69 73 18 420 438 Improved cement grinding 4 41 45 11 151 162 Total 107 564 671 177 1,804 1,981 Beijing EMC Efficient lighting in chicken farms 7 142 149 5 133 138 Efficient commercial lighting 17 280 297 9 165 174 Boiler renovations 9 189 198 4 103 107 Steam & air hammer replacement 10 49 59 8 50 58 Condensed water recovery 25 347 372 38 681 719 Power transformer renovation 4 83 87 9 255 264 Efficient electric motor drives 6 90 96 6 121 127 District heating renovation 5 52 57 37 496 533 Others 9 97 106 24 341 365 Total 92 1,329 1,421 140 2,345 2,485 medium-size coal-fired boilers (primarily installation of one of a number of coal sorting devices developed in China for installation in fuel feed systems). Current individual company business plan characteristics are: * Liaoning EMC. Based on the special expertise and industrial relationships of company staff, this EMC is developing a strong initial business in electric arc furnace renovation work. Electric motor projects also is an area of major emphasis at this stage, complimented by a range of smaller boiler renovation and electric lighting projects. * Shandong EMC. Electric motor projects are an area of particular emphasis in Shandong. The company also has developed a line of projects to install improved insulation on industrial autoclaves. In addition to early implementation of smaller lighting projects, Shandong EMC also would like to Page 29 ANNEX 3 initiate a somewhat wider range of project lines during the first few years than the other EMCs, especially in waste heat recovery and installation of improved insulation for glass furnaces. Beijing EMC. Beijing EMC has placed greater emphasis on lighting projects than the others, developing projects in chicken farms, hotels, shopping centers and the subway. In addition to some initial development of boiler projects and investments to replace air and steam hammers with more efficient electrically powered industrial hammers, the EMC is also developing innovative project lines for recovery of condensed water (and its latent heat) in industry and for renovation of medium- size district heating blocks. The capabilities of the three EMCs to assess the market for business opportunities and adjust plans based on actual conditions, where necessary, has greatly increased over 1997, especially with the beginning of project implementation with EC support. Host enterprises for EMC projects include a variety of types of enterprises, and not only state-owned enterprises. Project and Host Enterprise Selection Criteria. To be eligible for EC, GEF or IBRD financing, projects must (a) be energy conservation investments (e.g., more than 50 percent of total project benefits accruing to the EMC must be derived from savings in host enterprise energy costs); (b) yield an estimated net financial rate of return to the EMC of at least 15 percent per year; (c) employ the energy performance contracting mechanism; and (d) be undertaken in stable and financially sound host enterprises, as described further below. In addition, for projects to be eligible for EC or GEF financing, each project must have distinct demonstration value: each project should demonstrate application of the energy performance contracting mechanism in a new product line or technological application, in a different type of host enterprise, or with a different type of savings verification or contracting arrangement. Especially during the early years, EMCs should continue to select technical applications with minimal technical risk, relatively simple installation and implementation requirements, relatively simple energy savings verification requirements, high local replication potential, and quick financial payback periods. Although host enterprise financial requirements are different for energy performance contracting than for appraisal of loans, as payments to EMCs are treated as operating costs and not loan repayments, EMCs must still ensure that the enterprises hosting energy performance contracting projects are stable and financially sound. During at least the last year, host enterprises must have (a) shown a net profit, (b) maintained a debt to total assets ratio of less than 70 percent, and (c) show a credit rating of AAA or AA, or equivalent. In addition, EMCs should ensure that host enterprises have (a) sufficient liquidity to make payments on time, (b) demonstrated stable production and market conditions, (c) sound company management, (d) clear and stable company ownership, and (e) sufficient company size (assets). The above criteria were agreed by the Bank, SETC and the three EMCs at project appraisal and negotiations, and denote the commercial terms and subproject criteria acceptable to the Bank referred to in the Project Agreement. Project Approval Requirements PMO and Bank approval of all energy performance contracting projects of the EMCs will be required prior to implementation unless and until this approval right is formally waved for specific project lines. Project feasibility reports and draft contracts will be submitted to the Bank through the PMO. The PMO and the Bank will place special emphasis on review of the technical and economic aspects of new project lines when projects in a new project line are first proposed. Once a sufficient number of pilot projects Page 30 ANNEX 3 have been implemented to demonstrate the technical and commercial viability of a specific project line in a specific EMC, the Bank and PMO may formally wave prior approval requirements for IBRD-supported projects for that project line for the duration of the project, although a revocation right will be retained. Table 2: EMC Demonstration Component Cost and Financing Current US$ million EC grant La 4.5 GEF project grant -15.0 Domestic loans, through SETC 30.9/b IBRD loan 63.0 EMC internal sources 23.4 Total 136.8 /a Effective June 1997. /b 300 million yuan, valued at US$36 million at the 1997 exchange rate, and US$30.9 million in current terms. B. INFORMATION DISSEMINATION COMPONENT Concept and Outputs This component will support the development of a new system to develop and provide practical information on energy conservation project results to Chinese enterprise managers. The system will be operated by the new Energy Conservation Information Dissemination Center (ECIDC), functioning under a performance contract with SETC, established on January 9, 1998. ECIDC will oversee the development of new information products, patterned after highly successful models in developed market economies, and the dissemination of these materials primarily through channels already existing in China. The new products, and function and operating framework of the Center, are to some extent patterned after the Energy Efficiency Demonstration Scheme (EED'S) and the Best Practice Program of the Government of the United Kingdom, but with major adaptations to Chinese conditions. This component includes US$10 million of support for the initial five years of the program. SETC grant financing of US$5 million will support the core costs of ECIDC, and a core level of product development and dissemination. GEF grant financing of US$5 million will support training and institutional capacity building, a portion of product development and dissemination, especially during the early, trial years, and program evaluation and monitoring. The new information products are being designed to better meet the needs of enterprise managers operating in the market economy. While there currently is a wide range of publications and newsletters in China on energy conservation measures, the information focuses virtually exclusively on technical aspects, and is geared primarily to an audience of enterprise, research institute or industrial bureau engineers responsible for energy conservation work. Production and dissemination of these technical materials is typically not very systematic, and is both geographically and institutionally highly fragmented. In contrast, the new information products will be geared towards a wider audience and especially industrial enterprise managerial and senior engineering staff responsible for investment decisions. All materials will be based on verifiable information from actual projects undertaken in Page 31 ANNEX 3 Chinese enterprises. Particularly strong emphasis will be given to financial results actually achieved by enterprises (and the factors underlying these results), problems and solutions during implementation, any impacts on main enterprise production or other key risks, and contact information on enterprises with relevant experience. All materials will be presented in a standard, easily recognized, professional format, with the authoritative endorsement of ECIDC backed by SETC, and disseminated nationwide in a systematic fashion. The two key new products include: * Case Studies. A case study will provide independent, authoritative information on specific energy efficiency measures with high replication potential, implemented by specific industrial enterprises. The implementation of a measure at a host enterprise will be observed by an independent monitoring contractor appointed by ECIDC. Measurements and surveys will be taken before, during and after the measure is implemented. The case study documents will typically be about 4 pages, including pictures, drawings and graphs, and focusing on costs, financial results, impacts on meeting energy use or environmental regulations (if relevant), before-and-after analysis, implementation and operational experience, "tips" for others, and contact information. About 100 case studies will be completed under the project, beginning with about 10 during the first year and increasing to about 25 per year during the fourth and fifth year. - Technical Guides. The technical guides will provide enterprise senior technical and energy managers with authoritative information on a range of energy savings options within a given technical category (e.g., electricity savings in electric pump applications, or energy management systems in the cement industry). The guides will complement the case studies, which feature one measure each. They will be prepared by recognized experts on contract with ECIDC. Each guide will typically include (a) process description and energy saving opportunities; (b) technical description and advantages and disadvantages of key energy saving options; (c) possible nonenergy benefits; (d) considerations in equipment selection; (e) implementation and operational experience in various enterprises, and how to avoid common pitfalls; (f) costs, financial benefits and financial risks, base on case histories; (g) decision trees detailing circumstances in which different technologies or techniques should be used; and (h) sources and contacts for further information. It is planned to complete about 17 technical guides under the project. Dissemination will be a key activity of ECIDC. Based on the proposed performance contract, ECIDC will ultimately be judged not on how many case studies or technical guides it produces, nor the quality of these materials, but on how many industrial enterprises actually use the information to implement projects. Thus ECIDC must disseminate material of sufficient impact and content, and in an appropriate manner, to result in increased investment in energy conservation measures by enterprise decisionmakers. In addition to distribution of the case studies and technical guides, ECIDC plans to (a) produce short newsletters; (b) conduct workshops, site visits and seminars; (c) publish articles in a variety of relevant journals describing its case studies and guides; (d) operate a database of information program outputs and, possibly, equipment suppliers; and (e) operate an Inquiries Bureau. As vehicles and partners in conducting direct mailings, workshops, site visits, and seminars, ECIDC will work closely with local Economic and Trade Commission offices and affiliated institutions, energy conservation units in the industrial line ministries, local Industrial Bureaus, the China Energy Conservation Association and its local representatives, and other institutional networks. Useful fora include a full range from regular government work conferences to local trade exhibitions. Page 32 ANNEX 3 Institutional and Implementation Arrangements ECIDC will operate under the supervision of the Resource Savings and Comprehensive Utilization Department of the SETC, based on a performance contract. At negotiations, it was agreed that the performance contract will include at least (a) a description of services to be provided, deliverables and work program targets; (b) approval procedures for annual plans; (c) key performance indicators, including energy savings targets, agreed methodology for monitoring these indicators, and any other evaluation criteria; (d) financing arrangements and financial management requirements; (e) subcontracting provisions; (f) supervision and management role of SETC's PMO; and (g) reporting requirements. The performance contract will specify required levels of proven annual energy savings stimulated by ECIDC's activities (ramped up with time). ECIDC will therefore need to closely rnonitor and survey the results of its activities, according to agreed procedures. Based on UK experience, this will provide the Government (and GEF) with a useful measure of the cost-effectiveness of use of public funds. It also is incumbent upon ECIDC to carefully target technologies, its audience, material formats, and dissemination work to achieve the maximum results in verifiable energy savings at least cost. Strategy development, market research and self-evaluation of activities to allow mid-course corrections are all important areas for ECIDC's work. ECIDC is a not-for-profit public service entity, an independent legal person with independent accounting, and is intended as a permanent entity. Although ECIDC may generate a small level of revenue, many activities must be free to users (e.g., distribution of case studies), or provided bellow full cost (e.g., technical guides), in order to meet the objectives of the program, as is the norm in other countries. Revenues might be generated through small fees for certain products or advisory services, but areas where revenue generation is allowed must be explicitly and precisely listed in the performance contract, to avoid conflicts with broader program interests. ECIDC will require some continued Government funding after the five years of project implementation. The core staff of ECIDC will be engaged as long-term employees, working full time and only for ECIDC. Three initial core staff were engaged as of January 1998. Table 3: Information Dissemination Component: Cost and Financing (Five Years) L/ (US$ million) GEF SETC Total A. Center Core Costs 0 2,400 2,400 B. Capacity building, training and technical assistance, including overseas 1,500 100 1,600 training, long-term and short-term program consultant and trainers, technical assistance for strategy, and market research and evaluation C. Products and product dissemination Case studies 1,700 1,100 2,800 Technical guides 450 200 650 Dissemination (seminars, work conferences, site visits, third-party events, newsletter, training of local energy conservation staff) 1,150 1,100 2,250 Subtotal 3,300 2,400 5,700 D. Evaluation 200 100 300 Total 5,000 5,000 10,000 La GEF-financed aspects include US$3.7 million in consultant services, and US$1.3 million for printing and measuring/monitoring equipment costs. Page 33 ANNEX 3 Building upon the existing project implementation plan prepared by the PMO, ECIDC will submit prior to April 1, 1998 its final project implementation and staffing plan, in form and substance satisfactory to the Bank, together with a financial plan satisfactory to the Bank for ECIDC's operation for at least a 10- year period. At project negotiations, the Bank obtained assurances that the SETC will enter into a performance contract satisfactory to the Bank with ECIDC no later than June 30, 1998, or such later date agreed with the Bank. C. PROGRAM MANAGEMENT AND MONITORING COMPONENT Activities This component includes (a) activities to support the proliferation of energy performance contracting among a wide variety of possible enterprises in China, to be implemented by the EMC Development Unit of the PMO; and (b) training and technical assistance for energy efficiency program management and support and evaluation of the project's other components to be implemented by the Project Management Unit of the PMO. The component will be supported with US$2.0 million of GEF financing for incremental costs and US$2.0 million equivalent of SETC grant financing for core costs, especially staffing costs. The EMC Development Unit will promote and assist the creation of new EMCs in China by any interested domestic or international parties. The success of the program and the unit staff will be measured by the number of new EMCs created and the successful operation of these EMCs. The Unit's operations will be supported with US$1.1 million of GEF funding. The Unit should undertake the following tasks: X Provide specific information on EMC development in China for dissemination to potential EMC organizers, Chinese financial institutions, government officials and foreign ESCOs. * Provide assistance, including the help of foreign experts, to any EMC organizer beginning an EMC company, including assistance on basic concepts, product lines, model contracts, financial models, and lessons learned. * Arrange conferences and workshops for potential EMC organizers, Chinese financial institutions and government officials. • Invite foreign ESCOs to review EMC development in China. * Provide assistance to foreign ESCOs in understanding what must be done to establish joint-venture EMC businesses in China, including basic "how to establish" documents, one-on-one discussions, and assistance discussions with appropriate officials. * Provide assistance to Chinese banks in understanding how they can finance EMC activities and potential benefits. * Provide willing EMC organizers, willing investors and willing foreign joint-venture lists for potential matchmaking. * Assist Chinese businesses wishing to develop energy performance contracting by providing materials on the basic concepts, model contracts, essential elements of business plan outlines and model generic plans, generic product line technical assessment, benefits analysis, savings verification options and commercial terms of contract, and legal aspects. * Assist the PMO in the design of the GEF Phase II EMC Expansion and other potential international donor agency projects by providing details on the lessons learned from the three EMC demonstration, the experience gained in working with EMC organizers to create new EMCs, what barrier are critical, and how to overcome them. Page 34 ANNEX 3 Capacity building and monitoring/evaluation activities of the Program Management Unit supported by GEF financing are planned to include US$500,000 for training and US$400,000 for consultants services: * Training courses in energy economics for staff working on energy efficiency and nominated by the SETC; * Training and further assessment of intemational experience in ESCO management and operations; * Engagement of consultants to help the PMO provide technical assistance to the EMCs on a wide variety of issues, conduct project monitoring and evaluatio:n activities, and undertake technical evaluation of proposed new EMC project lines; * Completion of independent project reviews. TABLE 4: PROGRAM MANAGEMENT AND MONITORING COMPONENT: COST AND FINANCING (US$ million) GEF SETC Total A. EMC Development Unit 1.1 1.0 2.1 B. Program Management Unit Training 0.5 0.5 Expert Consultants' Services 0.4 0.2 0.6 Core Costs 0.8 0.8 Subtotal 0.9 1.0 1.9 Total 2.0 2.0 4.0 D. TOTAL PROJECT COSTS AND FINANCING Table 5 provides a summary of the costs presented in Tables 2-4, in standard World Bank investment project format. TABLE 5: SUMMARY OF ESTIMATED PROJECT COSTS (US$ million) Project Component Local EForeign Total EMC Demonstration 27.7 61.7 89.4 Information Dissemination 4.7 3.1 7.8 Program Management and Monitoring 2.8 0.4 3.2 Total Base Cost 35.2 65.2 100.4 Duties and Taxes 24.0 0.0 24.0 Physical Contingencies 1.7 3.1 4.8 Price Contingencies 11.3 10.3 21.6 Total Project Cost 72.2 78.6 150.8 Page 35 ANNEX 4 ANNEX 4: PROJECT JUSTIFICATION, INCREMENTAL COSTS, AND BENEFIT-COST ANALYSIS A. OVERVIEW Energy conservation in China over the coming decades is critical for the country's development and for the global environment. A major conservation effort is necessary to limit the otherwise huge increase in primary energy supply required to sustain the growth of China's economy and to mitigate the serious environmental consequences of expanded energy consumption. This project will support the introduction of a market-based approach to financing energy conservation investments-energy performance contracting-which has the potential to overcome some of the major impediments to energy conservation in China (see Annex 2). Secondly, the project will support the introduction of a new nationwide energy information program, providing consumers with information on financially attractive energy conservation investments. Economic and financial analyses demonstrate that the potential benefits of the project-both for China and the global environment-are enormous. However, to achieve these benefits, it is necessary to introduce, demonstrate, and disseminate an entirely new concept to China, which requires the establishment of new institutional rules and practices. Energy performance contracting (the ESCO concept) provides a unique solution to China's current energy conservation investment program, which has become less effective as the economy has become more market-oriented. Studies have shown that there are a wealth of profitable energy efficiency investments in China, particularly within the industrial sector. However, a number of barriers have limited the extent to which such investments have been undertaken by enterprises themselves. By limiting the technical and financial risk to host enterprises, and providing a financial incentive to both the host enterprise and the pilot energy management companies (EMCs) that have been established under the project, the ESCO concept has the potential of dramatically increasing investment in energy conservation. However, because the ESCO concept is new to China, there is considerable risk. EC and GEF grant resources are necessary to reduce these risks during a demonstration phase. A different type of energy information system is also required for China's transitional economy. At present, information on energy conservation at both the central and local level is primarily technical in nature, is disseminated irregularly, and does not focus on the financial returns of conservation investments to enterprises and other prospective users of such information. While an extensive information delivery system remains in place in China (see Annex 2), the informnation currently provided does not entice enterprises to invest in energy conservation on their own. The new program will provide energy consumers with information on "best practice" energy conservation investments with high financial returns in a number of industries and for various technologies. B. BENEFITS The project will result in significant additional energy savings in China and associated reductions in greenhouse gas emissions through the demonstration and dissemination of energy performance contracting via the EMCs and the establishment of a new market-oriented energy information program. The project will also produce other environmental benefits associated with energy conservation, such as Page 36 ANNEX 4 the avoided health consequences of local air pollution and the avoided regional impacts to agriculture and ecosystems from acid rain. Energy Conservation. Direct project benefits include energy savings from: (a) energy conservation investments by the three pilot EMCs; and (b) enterprises undertaking energy conservation investments by themselves as a result of the improved energy information program. Total energy savings associated with the initial three EMC's operations (Table 1) have been calculated based on the energy savings from EMC investments identified so far, and the number of such invesitments approved during appraisal (see Annex 3, Table 1). Energy savings for the three pilot EMCs include investments undertaken during the first 10 years of operation. The energy savings associated with the new energy information program have been estimated based on the experiences of a similar program in the United Kingdom during the 1980s and early 1990s. TABLE 1: PROJECT BENEFITS Energy Savings CO2 Reduction (million tons coal equivalent) (million tons carbon) Three Pilot EMCs /a 45 34 Energy Information Program 24 18 Total 69 52 /a Estimates are based on the EMC business plan targets. Global Environmental Benefits. The proposed project would contribute to significant reductions in carbon dioxide emissions over the medium term. Energy conservation investments planned by the three EMCs in their business plans are estimated to result in the reduction of around 34 million tons of carbon (MtC). Carbon dioxide emissions reductions are estimated to total 18 MtC for the new energy information program. The estimated direct benefits from EMC investments during 1998-2006 would accrue during 1998-2016, with about 60 percent of the benefits achieved during 2007-2016 from the continuing energy savings of the increasingly large investments of the EMCs during the final years of project implementation. Under a more conservative scenario, whereby only about 70 percent of the energy savings and carbon reduction expected in the EMCs business plans are actually achieved, carbon reduction directly resulting from EMC investments during 1998-2006 would total about 24 MtC, of which 9.2 would be achieved during 1998-2006, and the balance of some 14.8 MtC from the 1998-2006 investments would accrue during 2007-2016 (performance indicators in Annex I are based on this more conservative assumption). The cost to GEF for carbon reduction directly related to the three pilot EMCs and information program is estimated to be 40-60 US cents per ton of carbon, depending upon the scenario. This cost compares very favorably to GEF investments in other countries, valued at several dollars per ton of carbon, and damage estimates used by GEF and many developed countries of US$20 dollars per ton of carbon. Additional benefits from this project are expected to result from further dissemination of the EMC concept in China. With additional follow-up, as proposed in the Phase II EMC Expansion, additional carbon dioxide emissions might amount to three or more times the estimates here, further improving cost effectiveness. Page 37 ANNEX 4 Additional Domestic Benefits. Energy efficiency projects have been shown to result in substantial reductions in the emissions of both particulates and sulfur, principally through the reduction in energy consumption, but also through the introduction of more sophisticated technologies that are less pollution- intensive and that often embody pollution control technologies. Based on case studies of energy efficiency carried out as part of the China GHG Study,' the project could reduce particulate emissions by 2.5 million tons and sulfur emissions by 3.3 million tons over the life of the project. Such reductions in local air pollutants, especially fine particulates, would result in large health benefits for residents, by reducing ambient concentrations, and thereby reducing human exposure and the incidence of respiratory illnesses. Reductions in sulfur emissions and concentrations would lessen the impact of acid deposition in certain parts of China, and thereby reduce the impacts on crops, ecosystems, and materials.2 C. BARRIERS TO INTRODUCING ENERGY PERFORMANCE CONTRACTING IN CHINA If the barriers to energy performance contracting can be successfully demonstrated in China as a result of this project, the potential benefits as outline above, are enormous. The principal constraint is not technical or financial risk, but the lack of information and experienced institutions that are required for the energy performance contracting market to function. Information. Energy performance contracting is a new concept in China. Potential host enterprises with potential energy conservation investments are unfamiliar with energy performance contracting. Given China's history of central planning, enterprise managers in China are even more concerned with physical output, and are therefore risk averse in allowing an outside "service company" into their enterprise to replace equipment or alter production methods. International ESCOs, while potentially interested in undertaking energy performance contracting in China, are unaware of the rich potential of energy efficiency investments-much of the potential is in the industrial rather than residential/commercial sector. While governments, both central and local, are interested in replacing the current energy conservation program with a self-financing and market-oriented solution, they too are unfamiliar with the concept, particularly how it would be adapted to Chinese conditions. Domestic banks, which must shoulder the financing of EMC operations, are not familiar with energy performance contracting, and have not been particularly keen on financing energy conservation investments in general. Experience. Although ESCOs have been successfully operating in many developed countries for over 15 years, no companies have yet used energy performance contracting in China. Both domestic and international companies lack the experience in designing and structuring energy performance contracts in China, which can only be worked out by signing such contracts and carrying them out. Even more so than other businesses, contracts will directly determine the profit of the ESCO, and the financial benefit to the host enterprise. Once energy performance contracts are demonstrated and perfected, it is expected that both domestic and international ESCOs will become established in China and flourish. Host enterprises are likely to be wary of energy performance contracts until they have been proven in similar enterprises and endorsed by local or national government energy conservation agencies. Johnson and others (eds). 1996. "Issues and Options in Greenhouse Gas Emissions Control," World Bank Discussion Paper No. 330, Washington, DC. 2 Estimates of the human health and other impacts of fine particulates and sulfur has been evaluated in a recent report by the World Bank (1997), "Clear Water, Blue Skies: China's Environment in the New Century," China 2020 Series, Washington, DC. Page 38 ANNEX 4 The Missing Market. In essence, none of the components necessary for establishing a market for energy performance contracting in China yet exists. (a) Without information about ESCOs and seeing practical results on the ground, there is no effective demand for energy performance contracts by host enterprises. (b) No Chinese ESCOs have been established and no international ESCOs have yet been willing to enter the market. (C) Except for initial pilot efforts associated with this project, no energy performance contracts have been drafted, signed, and their conditions fulfilled. Energy performance contracting in China will require introduction and adaptation to China's unique economic, regulatory, and legal situation. In fact, until the proper institutional mechanisms are established-including ESCO companies, but also regulatory experience governing and protecting Chinese ESCOs and host enterprises-there can be no market for energy performance contracting in China. D. EMC DEMONSTRATION VS. DEVELOPMENT Given the barriers to energy performance contracting mentioned above, it is essential that the concept be both introduced and demonstrated in China prior to widespread commercial development. Because energy performance contracting companies do not currently exist in China, there is a significant amount of learning through on-the-ground business operations that must be acquired by the newly established EMCs. Demonstration of the ESCO concept would take place during the pilot phase. For purposes of this project, the "pilot phase" for the EMCs is defined as the trial implementation of individual "product lines"-including technologies, users, and contract types. Not all of the individual project investments undertaken by the EMCs during the pilot phase would be suitable for follow-up commercial EMC investment, either because of marginal economics in light of large transactions costs, or difficulties in contracting or energy savings verification. The initial demonstration of different product lines would be supported by EC, GEF, and SETC grant resources. Once a product line has been proven, follow-up commercial development could proceed using IBRD and domestic bank loans. Outside reviewers of the project, familiar with the development of ESCOs in the United States and Canada, have stressed that adequate time (three to five years) must be allowed to introduce and demonstrate the ESCO concept and for the initial pilot companies to become established. The pilot phase of the project began in 1997 using grant resources from the EC. Additional product lines would be demonstrated in 1998 using GEF and SETC grant resources. Commercial development using IBRD and domestic loan funds could begin immediately following successful demonstration of individual product lines. In the United States and Canada, energy performance contracting was aided by various types of federal and state support for more than 10 years, before the concept was finally commercialized. In the process, many ESCO companies were established and many went out of business. A small subset of possible energy conservation investments would be carried out under the pilot phase for diffierent consumers, technologies, and contract types. Aside from helping the EMCs to identify high-return product lines and workable contract types, the pilot phase would be used to demonstrate the shared savings concept to potential clients, financial institutions, government agencies, and international private sector. E. INCREMENTAL COSTS Following the GEF methodology for financing of global environmental projects, the incremental costs have been defined as the difference in the cost of the project with global benefits, compared to costs of the baseline. In essence, the additional costs are those of introducing and demonstrating the EMC concept in China and the new aspects of the energy information program. Only by incurring these incremental costs can the additional energy and CO2 reduction benefits outlined in Section B above be achieved. Baseline Page 39 ANNEX 4 In the absence of the GEF alternative, China's energy conservation program would likely remain in its present form for the near term. However, it would likely continue to decline in size and effectiveness as the market economy develops. Information on energy conservation is provided at both the central and local level, however, such information is disseminated irregularly, is primarily technical in nature, and does not focus on the financial returns to enterprises. Investments in energy conservation would remain primarily a government function, and would continue to entail providing subsidized loans to enterprises for qualifying energy conservation investments. China's energy conservation investment system is largely a carryover from central planning, and would continue to be reduced in effectiveness through declining central government funds and more limited influence by the government over industrial operations. Under the baseline, there would be little or no private sector investment in energy conservation in China. Costs. Baseline expenditures on energy conservation by SETC during the Ninth Five-Year Plan (1996- 2000) in the three provinces relevant for the EMC Demonstration Component (Beijing, Shandong, and Liaoning) is about US$36 million. The current Ninth Five-Year Plan allocation and spending by SETC on energy information is in the range of US$5 million, while estimates for current overall program management are US$2 million over five years. The cost of energy conservation activities under the Baseline Scenario is estimated to total US$43 million. GEF Alternative The GEF alternative will introduce a market-based approach to financing energy conservation investments-contract energy savings-and thus overcome some of the major impediments to energy conservation investments in China today. Secondly, the project will introduce a nationwide energy conservation system designed to provide energy consumers with information on "best practice" in a number of industries and for various technologies. In particular, the new information system will emphasize the financial returns to energy conservation investments to make such investments attractive to enterprise management and to financiers. EMC Component. The incremental costs of establishing EMCs are the costs associated with introducing the ESCO concept to China and demonstrating to potential host enterprises and domestic banks that energy performance contracting is financially attractive. The costs of establishing and demonstrating the three EMCs over a five-year period is estimated at US$56 million. During the pilot program, SETC will provide concessional loan capital of approximately US$36 million for financing replication projects and working capital requirements, while EC and GEF funds would be limited to new applications.3 Only where the ESCO concept is being demonstrated in a new application (i.e., technology, consumer, contract type) would it qualify for incremental cost financing. Once applications of the ESCO concept have proven successful during the pilot program, funding would be available for commercial development from the World Bank (US$63 million), and from EMC internal sources (US$23 million). Because the domestic benefits of the EMCs, once established, are expected to be large, grant resources (EC/GEF/SETC) will cover only the startup costs and initial pilot demonstrations. These costs will include: (a) EMC institutional capacity building (e.g., financial, legal, and technical services; measuring and monitoring equipment); (b) upfront contract energy program development costs in identifying, testing, and refining the technical product lines of the three EMCs (e.g., energy-efficient lighting, 3 SETC loan capital of 300 million yuan is valued at US$36 million at the 1997 exchange rate, but is estimated to be equivalent to US$31 million in current terms at the projected dates of expenditure. Page 40 ANNEX 4 electrical motor systems, heating and cooling, and heat recovery equipment); (c) working out and pilot testing of viable contract terms between enterprises and the EMCs, suitable for Chinese conditions; (d) establishing and agreeing with enterprises and pilot testing viable verification, monitoring, and measuring protocols for the EMCs; (e) intensive monitoring of all aspects of the project, and completion of a full evaluation of the pilot phase; (f) completion of revised EMC business plans, to be supported with loan financing from the IBRD and domestic banks, and a nmarketing and dissemination plan for developing EMCs on a broad scale in China; and (g) establishing monitoring and evaluation criteria for the project. Information. The GEF alternative includes institutional reform and strengthening of the program to encourage the dissemination and adoption of cost-effective energy saving measures (including staff training, workshops, case study program development, and materials preparation and production). While China currently lacks a national-level information program for promoting energy conservation, the Chinese government has committed itself to a national energy information program and has agreed to provide core support for at least five years for the establishment and operation of a new National Energy Efficiency Information Center (Center). Establishment of a new national energy information program, focusing on the dissemination of financially-attractive "best practice" investments to enterprise decisionmakers, is estimated to cost around US$10 million. Incremental expenses of the information program include: (a) expertise required for the design of the "best practice" components of the new national energy information program; (b) training of PMO and Center staff, and contract consultants in the establishment and operation of a "best practices" program; (c) production of a number of technical guides and case studies in the first five years of the program; and (d) monitoring and evaluation of the information program to assess its effectiveness. Total Incremental Costs The cost of Phase I activities aimed at removing barriers to energy conservation under the GEF Alternative is estimated at US$70 million. The incremental cost of Phase I global benefits is estimated to be US$27 million. As the EC has approved US$5 million equivalent in financial support for barrier removing activities during 1997-98, GEF funding of US$22 mill[ion is proposed to support Phase I project implementation. Page 41 ANNEX4 TABLE 2: INCREMENTAL COST MATRIX Baseline Alternative Increment Domestic Benefits * A given level of energy ser- * The same level of energy * Barriers removed vices are provided to enter- services is provided in each * 69 Mtce of energy saved prises in each province province * More information * Current level of energy infor- * Information, risk, and financing disseminated mation (primarily technical) barriers are removed in 3 * More institutional strength- provided to enterprises provinces ening and closer progran * Current level of institutional * Additional 69 Mtce of energy management/supervision support and program manage- saved ment provided for energy * Additional energy information conservation (primarily financial) dissemi- nated to enterprises * Greater institutional strengthen- ing and program management | Global Environmental GHG emissions associated with GHG emissions associated with 52 Mt of carbon reduced Benefits the provision of above level of the provision of above level of energy services, energy infor- energy services, less those asso- mation, and institutional support ciated with additional energy savings Costs by Component (US$ million) EMC 36 56 20 Infornation Dissemination 5 10 5 Program Management and Monitoring 2 4 2 Total Costs 43 70 27 EU/EC Contribution 0 5 5 GEF Incremental Costs I 22 F. BENEFIT-COST ANALYSIS FOR LOAN If energy performance contracting can be successfully introduced and demonstrated in China during the pilot phase, the potential economic benefits of the project are enormous. Benefit-cost analysis has been done for the EMC component, with the caveat that not all future investments that will be financed under the project have been identified and fully analyzed. Of the subprojects evaluated so far, the economic internal rates of return (EIRR) of EMC investments range from 30-90 percent, with the overall EIRR of the project estimated as 47 percent. These benefits would be shared between the host enterprise and the EMC. Financial internal rates of return (FIRR) to the EMCs for the same investments are in the range of 20-25 percent. Present Value of Flows US$ million Economic Analysis Financial Analysis Benefits 1,118 Costs 793 Net Benefits 325 IRR (%) 47 20/a La FIRR to EMC only. Page 42 ANNEX 4 Based on the economic cost-benefit tables that were prepared for the three EMCs and for the project as a whole, analyses were performed to assess the economic sensitivity of the project to various changes in parameters: (a) Subproject failure. This is defined as any situation which reduces the benefits of the project (without reducing EMC investment costs), such as lower than expected energy savings or lower unit energy costs. For moderate reductions in overall project benefits (10-20 percent), the EIRR of the overall project remains above 35 percent. Only if overall subproject benefits fall by more than 50 percent, would the EIRR fall below a discount rate of 12 percent. (b) Technical failure of entire product line. If entire product lines fail to generate any benefits, the drop in the EIRR ranges from 3 percent to 17 percent, depending on the EIRR of the individual product line and the share of investment in it by the EMCs. Two major product lines (e.g., arc furnace renovation and adjustable speed drives) would have to fail for the EIRR to fall below 12 percent. This analysis has also made the unreasonable assumption that there is no learning by the EMC-e.g., all planned investments continue to be made in the failed technical product lines. Relaxing this assumption would allow investment funds to flow to successful product lines. (c) Shortened lifetime of equipment. Small to medium reductions in the lifetime of energy conservation equipment have minor changes in the EIRR of the overall project. Only if the lifetime of energy conservation equipment drops by 70 percent, would the EIRR fall below 12 percent. (d) Poor Implementation. Poor implementation of projects by either the EMC or the host enterprise could result in higher labor and materials costs, less energy savings, and more frequent maintenance. For the analysis, poor implementation is assumed to result in higher operation and maintenance costs of the energy conservation equipment. Because the energy savings benefits are large for most projects, higher operating costs do not have a large impact on the EIRR of most product lines. For a typical investment (arc furnace renovation), operation and maintenance costs must increase by over 400 percent for the EIRR to fall below the discount rate of 12 percent. EIRR (%) Baseline 47 Subproject Failure energy savings 10 percent lower than expected 42 energy prices fall by 20 percent 36 Technical Failure-entire product lines generate no energy savings Boilers 43 Adjustable speed drives 30 Arc furnace renovation 30 Arc furnace and boiler renovations 26 Adjustable speed drives and arc furnace 9 Shorter Lifetime of Energy Conservation Equipment Life of all product lines declines by 10 percent 46 Life of all product lines declines by 60 percent 25 Life of all product lines declines by 70 percent I Poor Implementation Baseline EIRR for Arc Furnace Renovation 49 Operation costs for Arc Furnace increase by 10 percent 48 Operating costs for Arc Furnace increase by 440 percent 12 Page 43 ANNEX 4 As a final note on the cost-benefit analysis, it is somewhat misleading to focus primarily on the rates of return of EMC investments, which appear quite high. Rate of return analysis is important where capital scarcity is the primary constraint, however, information collected for this project as well as previous analyses of energy conservation projects in China show that other factors are the primary constraints to investment (see Annex 2). G. PROJECT RISKS EMCs. While the World Bank and the Chinese government share the belief that EMCs have great potential in China, energy performance contracting is a new and untried concept in China. Project risks for the EMC can be separated into the demonstration and development phases. Project risks are high during the demonstration phase and low to medium during commercial development. The economic (and financial) analysis is sensitive to a number of factors, which are summarized in Table 3. As mentioned elsewhere, the technical risk of the projects is low. All technologies are proven and have economic and financial advantages over current alternatives in China. Nonetheless, technical failure would affect both the financial and economic returns. Poor implementation, such as maintenance problems, is a more important concern for EMC investments. Failure to realize the energy savings of the project from poor implementation will result in reduced payments to the EMC and financial losses to the host enterprise, affecting both financial and economic returns. Contracting problems, or bad debts, will adversely affect the cash flow of the EMC, but, interestingly, will not affect the financial benefits of individual projects to the host enterprise or the economic benefits to the country, since the energy savings could still be realized. Likewise, problems with receiving payments on time (accounts receivable) would affect the financial benefits to the EMC but not the economic benefits. Of course, over the longer term, bad debts or accounts receivable problems could force the EMC out of business, which would reduce energy conservation investments and adversely affect the economic benefits of the project. Given the way contracts are being structured, low capacity utilization of the energy conservation equipment would not adversely affect the financial returns to the EMC, but would affect the financial benefits to the host enterprise and the economic benefits to the country. (Contracts are being structured to avoid the situation where the EMC is not paid for energy savings because the host enterprise is operating the equipment below historical levels due to nontechnical reasons.) Also, a shorter lifetime of the energy conservation equipment will adversely affect the economic returns of the project, and financial returns to the host enterprise. However, this will not affect the financial benefits to the EMC, since it will be paid off early in the lifetime of the equipment. TABLE 4.3: EMC RISKS AND FINANCIAL AND ECONOMIC IMPACTS Problems/Risks EMC Financial Impact Economic Impact Technical failure YES YES Implementation difficulties YES YES Contracting problems/bad debt YES NO Accounts receivable difficulties YES NO Low capacity utilization NO YES Shorter equipment lifetime NO YES The success of EMCs is critically related to the quality and enforceability of the contract between the EMC and the host enterprise. Thus, not only is it essential for the EMC to learn how to identify potential customers, and select good projects, but there is a need for commercial contracts to be designed and Page 44 ANNEX 4 executed. The active involvement of the SETC and the provincial Economic and Trade Commissions during project preparation and pilot demonstration is critical to coordinate adaptation to China's existing legal, taxation, and institutional management framework, and to assist in minimizing the risk of contract default. Extensive technical assistance during project preparation and grant resources for pilot demonstration will help to reduce risks. All of the technologies being disseminated by the EMCs are commercially proven both in China and abroad. Extensive review of all EMC investments will also be undertaken by the Bank during the pilot phase. As described elsewhere, the financial risks are being mitigated through project design and Bank financial covenants. Dissemination Risk. To be successful, the project must demonstrate the EMC concept in China, such that additional EMCs are established and thrive. The EMCs are being demonstrated in only three provinces, meaning that potential developers of the concept in other provinces must learn about the benefits and potential risks of establishing such companies in their own provinces. The risk that the EMC concept will not be disseminated is being reduced through extensive technical assistance during initial implementation (including conferences and workshops), and by plans for a follow-up Phase 1I EMC Expansion. In the end, the best means of disseminating the EMC concept is by showing enterprises, financiers, and government the win-win nature of market-based energy conservation. Information Program. For the information component, there are the risks of creating a new institution (the national information center). These risks are being mitigated by combining the new Center with China's existing energy information network and institutions. In addition, the Center will be given a contract with the Government for achieving energy savings, which will provide an important incentive for operational efficiency. Page 45 ANNEX 5 ANNEX 5: FINANCIAL ASPECTS OF THE ENERGY MANAGEMENT COMPANIES A. FINANCIAL PROFILE OF ENERGY MANAGEMENT COMPANIES IN CHINA Energy Management Companies are a unique kind of project developer. Unlike comparable companies elsewhere, they are in many ways an integral combination of an industrial enterprise and a bank/leasing company and require the managerial skills and business strategies inherent in both. Their financial success depends upon their ability to attract capital and bear all performance and credit/customer default risk in developing, financing, installing and, to a greater or lesser degree, operating energy efficiency projects. Their profits comprise both a markup on the installed project cost and an appropriate return on the outstanding balance of the funds used to finance the projects, less, of course, the costs of borrowings. In purely financial terms, these companies create and finance capital assets which are installed in, and then effectively leased to a variety of host enterprises for varying periods. These assets generate an uncertain revenue stream from actual measurable energy savings which is shared between the host enterprise and the EMC in an agreed proportion and for a predetermined period of time. At the end of this term all payments cease, title to the assets are transferred to the host enterprises, and any unrecovered losses are borne by the EMC. Experience in the United States and elsewhere has shown that the success of these companies is critically dependent upon their ability to (a) develop and efficiently replicate a limited number of small, sound and low risk project types with a relatively short payback, (b) maintain a prudent capital structure, (c) adopt conservative accounting practices, particularly in respect to when revenues are recognized, (d) assess the financial position and creditworthiness of their customers, (e) limit overheads and control costs, and (f) manage corporate growth within available resources. In order to succeed, the EMCs will need to possess or quickly acquire the diverse skills and discipline required to: * limit overheads, labor and other fixed costs, given the relatively high financial leverage that is necessary to support reasonable growth; * replicate a large number of small relatively uncorrelated projects in order to reduce the technical and credit risk' and minimize the effects of a downturn in energy prices by limiting the term of each project, at least initially; * keep to the core business and develop an intimate product knowledge of a limited number of product types in order to reduce unit costs, facilitate equipment procurement and enhance its comparative advantage. Diversification into other areas will distract management, stretch resources and, if anything, increase business risk; * resist the temptation to overextend the EMC by exceeding their natural sustainable growth rate by undertaking too many highly profitable projects with long paybacks; Depending on the degree to which the projects are uncorrelated, the aggregate risk of a large portfolio of projects/financial leases is less than the weighted average risk of each project or lease. Page 46 ANNEX 5 * enhance its financial standing and creditworthiness to attract the funds needed to sustain the business. This will to a large extent depend on the extent of its equity base, its financial structure and accounting policies (particularly revenue recognition), the quality of its lease portfolio, and the standing of its customer base. Initially this is limited and, in the absence of venture capitalists, the EMCs will require assistance from the State and multilateral lenders; and * systematically assess the financial standing and creditworthiness of its potential customers to reduce the provision for bad debts, develop market related model contracts and the means to strictly enforce the provisions of these contracts. B. FINANCIAL STATUS PROJECTED FINANCIAL PERFORMANCE Financial Model and Assumptions. A detailed financial model for each EMC was constructed to provide a proforma income statement, cashflow and balance sheet in nominal terms for a period of 10 years, with 1997 as the base year. These projections are consistent with International Accounting Standards (IAS) and the requirements of the Chinese authorities. The summary projections for each of the EMCs are presented in Tables 3-5 at the end of this Annex. They are based on: * a series of standard project lines including large numbers of similar types of energy performance contract projects. These have been derived from the demonstration projects which exhibit the desirable attributes of manageable size, replication, potential market size and low technical risk. The characteristics of each of these projects are in the project file and include capital cost, mark-up, recurrent costs, project term, and proportion of savings; * a project implementation plan forecasting the number of projects in each project line, which will be replicated annually by each EMC within their resources, financial constraints and loan covenants; * the capitalized cost of each project type comprising equipment cost, engineering and project management, marketing fee and cost of the technical audit; * revenue receipts calculated on the basis of a predetermined share of estimated energy saving in nominal terms for a predetermined term; * an average contract type used for all projects (although there will be variants). The typical share of estimated energy savings accruing to the EMC, required profit margin (including recovery of overheads, start up costs and provision for bad debts) and estirmated capital cost are used to derive the contract termn2 for each project type; * ownership of project assets transferred to the host enterprise only at the end of the contract term. The capitalized project cost is amortized over the term of the contract on an annuity basis. The recognition of revenue is therefor accelerated somewhat and contributes toward the equity base, which supports the borrowings required to generate and sustain a reasonable level of growth; and * estimates of local and foreign inflation. Currency risks and resulting losses are borne by the EMCs and are charged to profits as they occur. Other quantitative assumptions are outlined in Table 1. 2 Level payments derived from energy savings for a fixed term have been assumed. The term is determined on the basis of an annuity of the form Cap Cost= % x S x (1-f 1/(I+ty) r where: (a) Cap Cost is the installed cost of the project including recovery of overheads, (b) % is the agreed proportion of savings received by the EMC, (c) r is the rate of return required by management and includes cost of capital, risk premium and profit margin, and (d) t is the resulting term of the contract. Page 47 ANNEX 5 TABLE 1: MODEL ASSUMPTIONS Liaoning Beijing Shandong Accounts Receivable (days) 60.0 60.0 60.0 Provision for bad Debts (°) - Initial 15.0 12.0 15.0 - Longer-term 5.0 3.0 4.0 Domestic Inflation (% a year) 5.5 5.5 5.5 Real Exchange Rate (1997) 8.30 8.30 8.30 Tax - Turnover (%) 5.5 5.5 5.5 - Corporate (°/O) 33.0 33.0 33.0 Interest Rates (°/O) - Special Loan 11.7 12.0 12.0 - Overdraft 20.0 20.0 20.0 - Commercial 11.7 12.0 12.0 Reserves - Public Welfare Fund (°/O) 5.0 10.0 5.0 - Capital Public Reserve (%/6) 10.0 15.0 10.0 Corporate Structure and Financing. The EMCs were formed in 1996 under national regulations as shareholding companies, having limited liability and between four and six corporate shareholders initially, with an initial total share capital of 82 million yuan-comprising fixed assets, patents and cash. This will be augmented in 1997 and 1998 by zero percent nonredeemable preference capital from the Ministry of Finance of about 150 million yuan, which will be financed from European Union and GEF grants of ECU 3.2 million and US$15 million respectively. Financial Projections. These are new companies with limited experience and without a track record or domestic equivalents. The base case financial projections are therefor indicative and will undergo substantial change as the EMCs evolve. Nevertheless, the projections are realistic, provided the EMCs: * survive the high risks of the earlier years without suffering a reduction in equity; * are able to quickly identify and replicate successful and profitable projects with reasonable market potential; * further develop the management skills and experience to package and deliver a large number of small projects consistently without excessive overheads; and * maintain financial discipline, strictly control working capital, correctly assess credit risk and plow back a substantial portion of earnings into growing the business. The base case projections show that the EMCs will be able to establish a rising profit trend, extend their limited equity base, meet all debt service commitments and earn an adequate return on total funds invested. Net profit after tax is expected to increase rapidly initially as the companies prove their product lines, develop and exploit their regional market potential and reduce losses from project failures and customer defaults. This will reach levels of around 400 to 500 million yuan a year in nominal terms before moderating in the face of market saturation and competitive pressure on profit margins as indicated in Figure 1. The financial performance is underpinned by a strategy of confining the EMC activities to a large number of small but profitable short payback projects which will minimize risks inherent in the business by: (a) project and customer diversification, (b) securing profit margins and (c) containing the adverse effects of unexpected inflation on what are essentially fixed price performance contracts. Page 48 ANNEX 5 FIGURE 1: NET PROFIT AFTER TAX The initial capital of the EMCs is limited. The equity 60.0 base of each EMC is projected to increase by an 50.0 - - - - Liaoning - average of 25 percent a year from the modest level of 40.0 S -handong ,_,__ - 28 million yuan in 1997 to 218 million yuan over the zo c30.0 ,- 10-year period as shown in Figure 2. This presupposes =-20.0 - - a conservative dividend policy with the payout ratio _~10.o E , 'rising only gradually to 20 percent as the companies mature, tight control of overheads and social o.o ., z-s O 8 g og g E obligations, effective working capital management -10.0 ''* @ > N > N N N 2 and the development of, and access to, commercial -20.0 credit in the longer term. On the basis of this the EMCs will be able to support borrowings of 210 million yuan and maintain a portfolio of energy saving projects of around 400 million yuan (US$35 million in nominal terms). FIGURE 2: EQUITY BASE Supported by the nature of the projects, strict financial 250 control and technical efficiency, the EMCs are _.200 - Liaoning projected to turnover their assets, (primarily the t | - - - Shandong capitalized aggregate value of the projects) about 1.1 1 50 ;, times each year. This, together with a relatively stable - profit margin of around 8 percent of sales will enable e 100 the EMCs to achieve a return on total funds employed 50 [ of between 8 and 9 percent a year as illustrated in Figure 3 and become financially self sufficient. These ° o> OD CD a CN0 projected returns compare favorably with the ESCO 0 0 a ° ° ° industry elsewhere in the world. C. FINANCIAL MANAGEMENT, CONTROL AND FIGURE 3: RETURN ON ASSETS EMPLOYED TECHNICAL ASSISTANCE 14 12 Financial Management and Control. The low risk 10 / - =c . _ strategy of pursuing a large number of small replicable 8- r ." ,.8 ....... _ projects, and the absence of a well developed financial o 2.. 6 - s >w~ ----- Liaoning services sector, substantially increase the importance E -.--Beijing E 4 l _ - - Shandong of proper inhouse financial management, especially for .....2il assessment of credit/default risk, credit extension and o -0------ ---- - control of accounts receivable. Commercial credit in -2 C) (D ° N ° N ° N N the form of project leasing, factoring and asset based lending is limited. EMC cashflow management is the key to the growth, viability and financial independence of the EMCs. The EMCs will, with the aid of technical assistance, need to establish a well staffed and competent accounting function skilled in: * assessing the creditworthiness of host enterprise comprising analysis of historic pretax interest coverage, funds from operations and free cashflow to total debt, ROI, operating margins and leverage etc.; * accurately recording a large number of transactions and managing an extensive and diverse portfolio of debtors; * cost recovery and contract pricing; * controlling costs, budgeting and projecting future cash requirements; and * fulfilling statutory requirements in running a quasi-private shareholding company. Page 49 ANNEX 5 Technical Assistance. The ongoing EC grant includes technical assistance to assist the EMCs to (a) establish the basic financial systems which are essential to operate and control companies of this nature; (b) provide basic training and guidance to the financial personnel; (c) develop the financial planning function; and (d) define financial policy and appropriate procedures. Further supported under the project management components of the GEF grant, where necessary, the technical assistance will include: * improvement of the financial models and refinement of the forecasts to reflect available resources, corporate capacity, financial constraints and sustainable growth; * assessment of the EMCs corporate structure, business environment, project inventory and resources and determination of: (a) appropriate financial structure, (b) critical success factors (debtors control and collection, contract pricing, cost control, corporate growth, etc.), (c) generic accounting structure (code of accounts and general ledger, payroll, a/c receivable, trade creditors etc.), and management information needed to address these factors; (d) cash management and security; and (e) integrated budgetary and cost control mechanisms; * preparation, design, supply, installation and commissioning of appropriate financial systems software, computer hardware and training; * review and amendment of the terms and conditions of the EMCs standard business contracts to reflect the EMCs financial policies; and * advice on the introduction of international accounting standards and auditing requirements acceptable to SETC and the Bank. D. PERFORMANCE TARGETS To minimize risk; ensure that conservative financial policies are established and implemented; and safeguard financial viability and solvency, the EMCs will take all the measures necessary to remain within the performance targets set out in Table 2. TABLE 2: FINANCIAL INDICATORS Year ended December 1997 1998 1999 2000 2001 2002 Beijing EMC Number of Projects(#) 5 22 65 133 140 171 Average Value of Projects (Y million) 0.7 1.4 1.6 1.5 1.6 1.6 Accounts Receivable (days) 60 60 60 60 60 60 Return on Assets (%) 0.0 0.0 6.0 6.6 7.1 9.6 Liaoning EMC Number of Projects(#) 13 33 57 82 93 93 Average Value of Projects (Y million) 1.9 1.6 1.8 2.0 2.3 2.5 Accounts Receivable (days) 60 60 60 60 60 60 Return on Assets (%) 1.2 1.6 6.1 6.5 10.2 10.0 Shandong EMC Number of Projects (#) 11 38 58 70 80 89 Average Value of Projects (Y million) 1.0 1.5 1.9 2.1 2.4 2.6 Accounts Receivable (days) 60 60 60 60 60 60 Return on Assets (%) 0.0 0.0 9.4 12.6 9.8 9.8 Page 50 ANNEX 5 E. FINANCIAL RISK ANALYSIS Sensitivity studies have identified that customer credit/default risk, collection period, the share of energy savings and project cost overruns will have the most significant impact on the viability of the EMCs. Probability distributions associated with each of these factors have been estimated. Table 6 provides a summary of the probability distribution associated with each of these factors and the motivation for its selection. Monte Carlo simulation techniques were used to assess the aggregate financial impact of these risks on each of the companies. The distributions and detailed results of the study for Liaoning are contained in the project file. These results, which are fairly representative of the three companies, are summarized in Figure 4. They represent the main indicators of financial health and show, notwithstanding a wide range of possible outcomes, that within 90 percent confidence limits that the company will be able to (a) maintain a profitable trend, (b) maintain a reasonably prudent financial structure; and (c) earn an adequate return on its investments. FIGURE 4: DISTRIBUTION OF PROFITS, DEBT:EQUITY RATIO AND RETURN ON ASSETS (a) Net Pdflts (b) Debt to Total Capitalization (c) Rturm on Assets 7000 80% 14% GMoo[ 0 70% mean 12% Io; mew _ 5 f6%[= Z 10%~~~~~~~~~~0 -1000D8 8 .,o,tt O § § -2%' XM N To alleviate this wide range of outcomes, management attention supported by specific technical assistance will be directed towards improving systematic credit assessment, establishing suitable personnel and credit control procedures to manage accounts receivables, and installing rigid policies in respect of the model contracts and commercial terms. F. REPORTING AND ANNUAL AUDIT The EMCs will: (a) establish and maintain proper financial practices and accounts from the commencement of project implementation and (b) complete the design, installation and operation of an appropriate computerized accounting system to record all transactions in accordance with Intemational Accounting Standards (IAS) and provide interim and annual financial statements reflecting the financial performance and position of both the EMCs and the project. The EMCs will also provide to the Bank a summary of the quarterly cost and operations report for the project detailing actual costs compared with budget for the quarter and year to date, together with an analysis of significant variances from plan. An example of the report format has been prepared for use by the EMCs and is available in the project file. This will be further refined during implementation of the financial/MIS technical assistance component, which is to be financed under the EC grant. The EMCs will also provide to the Bank, at the end of the first quarter of each year, a rolling five-year financial plan containing the investment program, production plan and projected financial statements. They will appoint, prior to the commencement of the financial year, a suitably qualified auditor acceptable to the Bank, who will provide an opinion and report on the statements, the adequacy of Page 51 ANNEX 6 internal controls, and compliance with financial covenants within six months of the EMCs financial year end. G. FINANCIAL COVENANTS At project negotiations, the three EMCs assured the Bank that they will: * not incur any further indebtedness unless its net revenues exceed, and are projected to continue exceeding, its debt service obligations by at least 1.6 times; * adopt and maintain a conservative capital structure and dividend policy throughout the duration of the loan such that total long term debt will not exceed 60 percent of total capitalization (net equity + total debt); * undertaken all projects on acceptable commercial terms and ensure that the average collection period of all accounts receivable does not exceed 60 days; * at the end of each financial year prepare the project accounts and annual financial statements in a manner consistent with IAS and the requirements of the Chinese authorities and together with an independent audit report, submit these to the Bank within 6 months of the financial year end; and * provide the Bank, by end March of each year, with a rolling five-year financial plan containing the investment program, business plan and projected financial statements; and taking into account the Bank's comments implement the plan thereafter. Page 52 ANNEX 5 TABLE 3: LIAONING EMC: FINANCIAL SUMMARY, 1997-2006 (10,000 yuan, in nominal terms) Year ended December 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Income Statement Operating income aftertumovertax 1,152 4,304 9,600 16,549 24,529 31,091 36,537 42,407 48,441 53,321 Project cost (incl depreciation) 771 3,125 7,066 12,199 18,227 23,260 27,411 31,832 36,506 40,338 Net operating income 382 1,179 2,534 4,350 6,302 7,831 9,126 10,575 11,935 12,983 Overhead, Interest and Tax 349 1,109 2,002 3,379 4,048 5,011 5,849 6,808 7,765 8,521 Net Income 33 70 532 971 2,254 2,821 3,277 3,767 4,170 4,462 Funds Flow Internal Sources 739 2,848 6,666 11,474 17,570 22,299 26,252 30,250 33,470 38,066 Borrowings - 2,599 3,121 4,579 5,086 3,378 3,547 3,589 3,606 2,416 Equity Investments 2,664 672 1,716 1,540 679 - - - 1,000 - Total Sources 3,403 6,119 11,504 17,593 23,335 25,677 29,798 33,839 38,076 40,482 Capital Expenditures 3,102 5,530 10,519 16,385 21,437 24,063 28,263 32,554 35,757 38,180 Working Capital Inc./(dec.) 242 642 960 1,319 1,247 1,181 983 1,059 1.101 897 Loan Repayments - - - - 500 500 500 300 1,151 1,248 Short Term Investments 59 (53) 25 (111) 151 (68) 52 (74) 65 157 Total Applications 3,403 6,119 11,504 17,593 23,335 25,677 29,798 33,839 38,076 40,482 Balance Sheet Current Assets 315 935 2,022 3,422 4,967 6,205 7,341 8,450 9,696 10,825 Less Current Liabilities 14 46 148 840 986 1,110 1,011 1,987 2,162 5,145 Net Current Assets 301 889 1,874 2,582 3,981 5,095 6,330 6,464 7,534 5,680 NetFixedAssets 2,395 5,144 9,455 15,170 20,694 24,473 28,796 33,526 37,335 40,180 Total Assets 2,696 6,033 11,330 17,752 24,676 29,568 35,126 39,989 44,869 45,860 Debt - 2,599 5,720 9,799 14,385 17,263 20,509 22,947 25,305 23,564 Equity 2,696 3,434 5,610 7,953 10,290 12,305 14,617 17,043 19,565 22,295 Total Equity and Liabilities 2,696 6,033 11,330 17,752 24,676 29,568 35,126 39,989 44,869 45,860 Financial Indicators Growth in Sales 0.0% 273.5% 123.1% 72.4% 48.2% 26.8% 17.5% 16.1% 14.2% 10.1% Return on Equity 1.2% 2.3% 11.8% 14.3% 24.7% 25.0% 24.3% 23.8% 22.8% 21.3% Return on Assets 1.2% 1.6% 6.1% 6.5% 10.2% 10.0% 9.8% 9.6% 9.4% 9.1% Net Profit Margin 2.7% 1.6% 5.2% 5.5% 8.7% 8.6% 8.5% 8.4% 8.1% 7.9% Current ratio 22.0 20.5 13.7 4.1 5.0 5.6 7.3 4.3 4.5 2.1 Debtto Total Capitalization 0.5% 43.5% 51.1% 57.2% 59.9% 59.9% 59.6% 59.4% 58.4% 56.3% Debt Service ratio - 2.2 2.8 2.8 2.3 2.5 2.6 2.9 2.1 2.0 Accounts Receivable (days) 60 60 60 60 60 60 60 60 60 60 Asset Turnover 0.45 0.75 0.89 0.94 1.01 1.07 1.07 1.07 1.09 1.11 Sustainable Growth Rate 0.0% 2.5% 14.7% 16.5% 24.1% 23.3% 22.6% 20.6% 18.4% 17.1% Page 53 ANNEX 5 TABLE 4: BEIJING EMC: FINANCIAL SUMMARY, 1997-2006 (10,000 yuan, in nominal terms) Year ending December 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Income Statement Operating Income 309 2,422 9,644 22,645 31,966 38,668 46,023 53,783 62,998 74,111 Project Cost (incl. depreciation) 558 2,293 8,169 18,903 26,899 32,222 38,324 44,769 52,344 61,667 Net Operating Income (249) 129 1,475 3,742 5,067 6,446 7,698 9,014 10,654 12,445 Overhead, Interest and Tax 37 321 831 2,415 3,355 3,635 4,324 5,068 6,027 7,173 Net Income (286) (192) 644 1,327 1,712 2,811 3,374 3,946 4,627 5,272 Funds Flow Internal Sources (47) 1,352 6,521 15,176 21,348 26,752 31,866 37,081 43,371 50,941 Borrowings - 1,203 4,134 6,233 2,459 2,801 2,766 3,151 4,507 5,301 Equity Investment 2,307 1,014 1,779 1,836 521 - - - - Total Sources 2,261 3,568 12,434 23,245 24,328 29,553 34,631 40,232 47,878 56,241 Capital Expenditures 1,622 3,747 11,208 20,749 22,473 28,237 32,710 38,037 44,465 52,168 Working Capital Inc./(dec.) 94 375 1,285 2,309 1,653 1,146 1,296 1,370 1,632 1,976 Loan Repayments - - - - - - - - 906 1,000 Short Term Investments 545 (554) (59) 81 65 (55) (50) 35 (51) 42 Dividends Paid - - - 106 137 225 675 789 925 1,054 Total Applications 2,261 3,568 12,434 23,245 24,328 29,553 34,631 40,232 47,878 56,241 Balance Sheet Current Assets 641 490 1,846 4,293 6,098 7,235 8,564 10,009 11,713 13,799 less: Current Liabilities 2 30 180 381 514 696 848 1,864 2,165 2,440 Net Current Assets 639 460 1,666 3,913 5,584 6,539 7,716 8,145 9,548 11,359 Net Fixed Assets 1,382 3,586 8,894 15,699 18,124 21,962 25,537 29,483 34,118 39,469 Total Assets 2,021 4,046 10,560 19,611 23,707 28,501 33,254 37,628 43,666 50,828 Debt - 1,233 5,517 11,950 14,543 17,525 20,443 23,704 27,512 31,959 Equity 2,021 2,843 5,223 8,042 9,679 11,671 13,658 15,788 18,319 21,309 Total Equity and Liabilities 2,021 4,076 10,740 19,992 24,222 29,197 34,102 39,491 45,831 53,268 Financial Indicators: Growth in sales 684.3% 298.2% 134.8% 41.2% 21.0% 19.0% 16.9% 17.1% 17.6% Return on equity (%) 0.0% 12.3% 16.5% 17.7% 24.1% 24.7% 25.0% 25.3% 24.7% Net profit margin (%/6) 0.0% 6.7% 5.9% 5.4% 7.3% 7.3% 7.3% 7.3% 7.1% Current ratio 296.3 16.2 10.2 11.3 11.9 10.4 10.1 5.4 5.4 5.7 Debt/capitalization 0% 30% 51% 60% 60% 60% 60% 60% 60% 60% Debt Service Ratio - 4.5 3.5 3.0 3.6 3.6 3.5 2.3 2.2 2.8 Accounts receivable(days) 60 60 60 60 60 60 60 60 60 60 Asset turnover 0.15 0.59 0.90 1.13 1.32 1.32 1.35 1.36 1.37 1.39 Sustainable growth rate (%pa) 0.0% 0.0% 22.6% 22.1% 18.5% 25.3% 21.7% 20.2% 20.5% 20.1% Return on total assets (%) 0.0% 0.0% 6.0% 6.6% 7.1% 9.6% 9.9% 10.0% 10.1% 9.9% Profit retention rate 100% 100% 100% 87% 87% 87% 75% 70% 70% 70% Page 54 ANNEX 5 TABLE 5: SHANDONG EMC: FINANCIAL SUMMARY, 1997-2006 (10,000 yuan, in nominal terms) 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Income Statement Operating income 594 4,536 11,338 17,027 23,396 29,540 36,120 40,744 45,285 49,560 Project cost (inci depreciation) 763 4,434 8,409 12,543 17,264 21,890 26,645 29,818 33,147 36,089 Net operating income (169) 102 2,929 4,484 6,132 7,650 9,475 10,925 12,138 13,471 Overhead, Interest and Tax 361 1,135 2,169 2,716 4,123 5,072 6,288 7,391 8,246 9,143 Net Income (530) (1,033) 759 1,768 2,009 2,578 3,187 3,534 3,892 4,329 Funds Flow Internal Sources 314 3,205 8,478 13,118 17,312 21,569 26,012 28,951 32,292 35,332 Borrowings - 2,041 2,902 3,357 3,871 4,423 5,437 1,969 3,043 3,117 Equity Investments 4,104 687 1,774 1,602 709 - - - - - Total Sources 4,418 5,933 13,154 18,078 21,892 25,992 31,449 30,920 35,335 38,449 Capital Expenditures 2,428 6,205 12,759 16,985 20,09:2 24,628 30,099 28,494 33,065 36,067 Working Capital lnc./(dec.) 113 724 1,248 1,011 1,127 1,117 1,197 820 821 769 Loan Repayments - - - - - 500 200 1,677 1,656 1,628 Short Term Investments 1,877 (996) (853) 82 672 (253) (47) (70) (207) (15) Total Applications 4,418 5,933 13,154 18,078 21,892 25,992 31,449 30,920 35,335 38,449 Balance Sheet Current Assets 2,001 1,768 2,227 3,416 5,329 6,295 7,556 8,341 9,016 9,832 Less Current Liabilities 12 51 114 211 824 626 2,214 2,229 2,261 1,995 NetCurrentAssets 1,989 1,718 2,113 3,205 4,505 5,669 5,342 6,113 6,754 7,836 Net Fixed Assets 1,585 3,552 8,526 13,929 18,1711 23,058 29,354 30,878 33,927 37,292 Total Assets 3,574 5,269 10,638 17,134 22,676 28,727 34,696 36,991 40,682 45,128 Debt - 2,041 4,942 8,300 11,671 15,894 19,654 19,968 21,383 23,200 Equity 3,574 3,229 5,696 8,835 11,006 12,833 15,042 17,023 19,299 21,928 Total Equity and Liabilities 3,574 5,269 10,638 17,134 22,676 28,727 34,696 36,991 40,682 45,128 Financial Ratios Growth in sales 0.0% 663.8% 150.0% 50.2% 37.4% 26.3% 22.3% 12.8% 11.1% 9.4% Return on Equity 0.0% 0.0% 17.0% 24.3% 20.3% 21.6% 22.9% 22.0% 21.4% 21.0% Return on Assets 0.0% 0.0% 9.4% 12.6% 9.8% 9.8% 9.6% 9.3% 9.5% 9.6% Net Profit Margin 0.0% 0.0% 6.3% 9.8% 8.1% 8.2% 8.3% 8.2% 8.1% 8.3% Current Ratio 167.2 34.9 19.5 16.2 6.5 10.1 3.4 3.7 4.0 4.9 Debt to Total Capitalization 0.3% 39.3% 47.0% 49.1% 53.2% 56.3% 59.2% 56.6% 55.1% 53.5% Debt to Service Ratio - - 5.9 5.9 4.4 2.6 3.3 1.6 1.7 1.7 Accounts Receivable(days) 60 60 60 60 60 60 60 60 60 60 Assets Turnover 0.18 0.90 1.12 1.04 1.05 1.06 1.04 1.10 1.12 1.11 SustainableGrowthRate - 23.5% 31.0% 20.5%/o 21.1% 22.4% 18.8% 18.3% 17.9% Page 55 ANNEX S TABLE 6: SELECTION OF PROBABILITY DISTRIBUTIONS Input Variable Distribution Motivation 1. Provision for Bad Debts. _ _ Initially the potential for credit default is likely to be A 2 higher as the EMCs develop their customer base in the absence of reliable credit assessment, track record or proper financial records. Accordingly a log normal distribution of bad debts was used with a std deviation of 4 percent about a mean ranging from 15 percent in 1997 to 3 percent in 2006. 2. Product Line Capital cost. f Notwithstanding that the technologies involved in I these projects are well developed, the real base-case | capital cost assumption could vary anywhere between +10 percent and -10 percent. A uniform distribution of ± 10 percent about the base case estimates has been L . used for each project type. WA mE 0s 1 3. Inflation Rate. A normal distribution varying within a narrow range of the long-term base-case estimate of 5.5 percent pa. This impacts not only costs but also projected nominal exchange rate projections and therefor foreign exchange exposure which is bome by the EMCs. 401 481 54% F i 7.0% 4. Number of Projects. Despite intense managemenat efforts to assess market potential and tool-up accordingly, there exists the possibility that the projected number of individual projects take longer to implement and peak at different levels to those projected. The assumed number of projects undertaken annually has 0 -T- accordingly been varied by a factor normally distributed (std dev. 10 percent) and rounded to a discrete number of individual projects. S. Energy Savings. Energy savings are critical to the success of the enterprise and are affect by many factors including energy prices, technical miscalculation, delays and savings verification. For conservative reasons it is assumed that there is a greater likelihood that the savings will fall short of present expectations as indicated by the adjacent distribution. 6. Unit costs. Unit operating cost in real temis is expected to vary by ± 10 percent of that originally assumed. .s~~~~ . 7. Accounts receivable. Given the present state of the financial sector and state-owed enterprises in China, the collection period 60 days could prove to be fairly ambitious. The chances of an in increase in the accounts receivable is more likely and the base-case assumption has been factored accordingly, Page 56 ANNEX 6 ANNEX 6: PROCUREMENT AND DISBURSEMENT ARRANGEMENTS A. PROCUREMENT Summaries of the procurement methods to be used for the project as a whole are presented in Tables A and B. Table Al, providing details of consultant selection arrangements, is in the project file. Further details of the procurement plans discussed and agreed during project appraisal and negotiations for each of the project's three components are provided below and in the project file. All procurement of goods will be carried out in accordance with the Bank's "Guidelines for Procurement under IBRD Loans and IDA Credits," dated January 1995, revised in January and August 1996, and September 1997. Model Bidding Documents, as agreed between MOF and the Bank, will be used for all international and national competitive bidding. Where no model document exists, the Borrower must use the relevant Bank Standard Document. TABLE A: PROJECT COSTS BY PROCUREMENT ARRANGEMENTS (in US$ million equivalent) Total Cost Procurement Method Consulting (including Expenditure Category ICB NCB OtherLa Services NBF contingencies) 1. Goods EMC Demonstration Component 10.2 11.1 80.1 30.9lb 132.3/b (7.8) (8.5) (61.7) (78.0) Information Dissemination Component Printing 1.3 1.3 (1.0) (1.0) Equipment 0.5 0.5 (0.3) (0.3) 2. Services Information Dissemination Component 3.7 4.5 8.2 (3.7) (3.7) Project Management & Monitoring 2.0 2.0 4.0 (2.0) (2.0) Total 10.2 12.4 80.6 5.7 37.4 146.3 (7.8) (9.5) (62.0) (5.7) (85.0) La Includes international and national shopping. lk Includes SETC loan financing only. Total new project investment by the EMCs over the 10-year project period, including projects financed with reinvested project revenues, is estimated at US$730 million, of which GEF and the Bank are financing contracts valued at US$101.4 million. Notes: (I) NBF = Not Bank-financed (includes elements procured under parallel cofinancing procedures, consultancies under trust funds, any reserved procurement, and any other miscellaneous items). (2) Figures in parenthesis are the amounts to be financed by the Bank loan/IDA credit. Page 57 ANNEX 6 TABLE B: THRESHOLDS FOR PROCUREMENT METHODS AND PRIOR REVIEW Expenditure Contract Value Procurement Contracts Subject to Prior Review/ Category (Threshold) Method Estimated Total Value Subject to Prior Review (US$'000) (US$ million) Goods EMC Demo Component -- ICB 10.2 1,OOO/a NCB 11.1 2,000La /b Shopping 40.0 Information Dissemination Printing 1,300/a NCB 1.3 Equipment 250 Shopping 0.0 Services Information Dissemination & - QCBS 2.2 Project Management 100 CQ 0.0 50 Individuals 0.0 Total value of contracts subject to prior review: 64.8 la Prior review above US$250,000.00 lb US$50,000 threshold for national shopping. EMC Demonstration Component Procurement is entirely for goods, using both GEF and IBRD financing, and conducted by the three EMCs with the assistance of a Chinese international tendering company. The three companies have begun procurement for a total of about US$3.7 million in goods financed through the EC Grant, according to Bank international shopping guidelines. The EMCs will buy the equipment for the completion of a range of energy performance contracts. The average energy performance contract size is US$200,000 during the early years, rising to an average of US$3 10,000 later in the project. Subprojects financed by GEF and IBRD are expected to total some 400 in number. Moreover, to operate their commercial leasing-type of business efficiently to meet the needs of their customers, the EMCs must execute their subprojects quickly following signature of energy performance contracts with their customers. Given the large number of small and varied contracts in this component, and the position of the EMCs as a type of commercially oriented financial intermediary, packaging of much of the goods procurement into packages suitable for International Competitive Bidding (ICB) is not feasible. For GEF and IBRD-supported projects as a whole, at least US$10.2 million in contracts is planned to be procured through ICB, accounting for about 10 percent of the total value of contracts financed by the GEF and IBRD. Qualified domestic manufacturers will be eligible for a margin of preference of 15 percent of the CIF price or the actual customs duty, whichever is lower, in the evaluation of bids. Up to US$11.1 million (US$3.7 million per EMC) will be procured through National Competitive Bidding (NCB), with procedures acceptable to the Bank. NCB is appropriate for a number of technologies that have been developed in China for retrofitting onto Chinese equipment (especially retrofitting of coal- fired boilers and various heat recovery schemes). Up to US$80.1 million (US$26.7 million per EMC) will be procured according to international and national shopping procedures acceptable to the Bank. International shopping procurement requires three quotations from two different countries and national shopping requires three quotations from qualified suppliers. Requests for quotations should indicate the description and quantity of the goods, as well as the desired delivery time and place. Page 58 ANNEX 6 Procurement plans for the first year of the project have been prepared by each EMC and are available in the project file. For contracts not subject to prior review, 20 percent will be subject to postreview during the first year. The coverage ratio can be reduced to as low as 5 percent in subsequent years, based on experience gained. TABLE 2: TYPICAL PROCUREMENT PROCESSING SCHEDULES (in calendar days) Selection of Consultants QCBS Advertisement procedure 60 Development of short list and LOI package 21 Bank review and clearance I 0 Request for proposals 10 Submission of proposals 45 Evaluation and award recommendation 35 Clearance of competent authorities 10 Bank no objection 15 Issue letter for negotiations 5 Negotiation and formalization of contract and draft contract to bank 21 Draft contract - Bank no objection 10 Contract signature 5 Mobilization 30 Total 217 International/Local Shopping Select requirement & list of suppliers 10 Solicit quotations 15 Evaluate quotation 10 Clearance of award by competent authorities 5 Total 35 Goods - Procurement ICB NCB Preparation of bidding documents (once technical specifications have been completed) 10 10 Clearance of bidding documents for Bank review by competent authority of borrower 20 5 WB review process & Bank no objection (including transmittal) 20 20 Subtotal 50 35 Advertisement procedure and release of bidding documents to bidder 5 5 Receipt and public opening of bids 45/60 30 Bid evaluation 30 20 Evaluation cleared by competent authority of borrower and transmittal to the bank 20 5 Bank review process and clearance (including transmittal) 20 20 Notification of award 5 5 Contract signature 10 5 Subtotal 135-150 90 Total 185-200 125 Information Dissemination Component Capacity Building, Training and Technical Assistance for Project Design, Strategy, Market Research and Market Assessment. Procurement for these aspects will be conducted according to QCBS procedures. One package or set of packages will be the primary vehicle for transfer of international knowledge and experience in the operation of commercially focused energy conservation information programs, and the development and dissemination of Case Studies and Technical Guides. The package will support a long-term "twinning"-type arrangement between the new ECIDC and Page 59 ANNEX 6 international advisors and trainers with a wide range of practical experience. Although advisory inputs- will be most concentrated during the initial years of the project, the relationship is expected to extend for the duration of the five-year component. The package(s) will cover preparation and delivery of training courses in China for ECIDC and local staff, arrangements and costs for overseas training, completion of a series of special studies, as well as hands-on operational advice and assistance from one long-term consultant and 6-8 short-term senior advisor assignments. All procurement of consultants will be according to the Bank's "Guidelines for the Selection and Employment of Consultants by World Bank Borrowers" of January 1997, revised in September 1997. All consulting assignments over US$200,000 must be advertised in Development Business. Another QCBS package or set of packages will provide support to ECIDC for design, implementation, continuous evaluation based on surveys, and periodic strategic correction of ECIDC's information marketing strategy and operational program. Consulting expertise combining international information marketing expertise and local expertise on how to maximize the impact of information in enterprise decisionmaking in China will be important. * Products and Product Dissemination. Key products of five years of program operation include about 100 case studies and about 17 technical guides. Although ECIDC is responsible for topic selection, determination of scope and quality control, these products will be prepared by independent contractors to ECIDC, printed by independent firms, and disseminated by ECIDC using a variety of channels, with contractor service assistance. During the first five years, GEF will finance about 58 percent of the cost of product production and dissemination, and the SETC will finance the balance. Printing services will be procured according to NCB procedures, consulting services will be procured according to QCBS and CQ procedures, and equipment will be procured according to shopping procedures. Evaluation and Monitoring. This will involve domestic contracting for a wide range of small-scale consulting services, averaging about US$40,000 per year and totaling US$200,000 in very small packages over the course of the project. Program Management and Evaluation Financed with GEF and government funds, this component will involve a range of very small contracts under US$100,000 each conducted over a five year period, totaling an average of US$400,000 per year and US$2.0 million over a five-year period. B. DISBURSEMENT Table C presents the allocation of grant and loan proceeds. For expenditures pertaining to goods contracts valued at less than US$250,000, consultancy contracts valued at less than US$100,000 for firms and US$50,000 for individuals and all training, reimbursement will be made on the basis of Statements of Expenditures. To facilitate disbursements, one Special Account for GEF funds will be established at the Ministry of Finance, and three Special Accounts for IBRD funds will be established at the three relevant provincial finance bureaus (Shandong, Liaoning and Beijing). The authorized allocation for the Special Account for GEF funds will total US$3.0 million, and the authorized allocations for each of the Special Accounts for IBRD funds will each total US$1.5 million. Applications for replenishment will be submitted monthly or when the amounts withdrawn equal 50 percent of the initial deposit, whichever comes sooner. Page 60 ANNEX 6 TABLE C: ALLOCATION OF GRANT AND LOAN PROCEEDS Expenditure Category Amount in Financing Percentage US$ million GEF Grant (1) Goods for pilot subprojects under Part A of the Project (EMC component) Shandong EMC 3.75 100% of foreign expenditures, 100% (ex-factory) cost and Beijing EMC 3.75 75% of local expenditures for other items procured locally Liaoning EMC 3.75 Unallocated 3.75 Subtotal 15.00 (2) Goods under Part B (information 1.30 100% of foreign expenditures, 100% (ex-factory) cost and component) 75% of local expenditures for other items procured locally (3) Consultants' services 100% Under Part B (information component) 3.70 Under Part C (program mgmt. component) 1.50 (4) Training (Part C-program management 0.50 100% component) Total GEF Grant 22.00 IBRD Loan Goods Shandong EMC 21.00 100% of foreign expenditures, 100% (ex-factory) cost and Beijing EMC 21.00 75% of local expenditures for other items procured locally Liaoning EMC 21.00 Total IBRD Loan 63.00 Page 61 ANNEX 7 ANNEX 7: PROJECT PROCESSING Planned Actual (At final PCD stage) A. Project Preparation and Schedule:GEF Critical Steps Time taken to prepare the project: 22 months First Bank mission (identification) n.a. 12/01/95 GEF IEPS/Technical review 03/08/96 03/08/96 GEF Approval of $350,000 PDF B 05/14/96 05/14/96 GEF Approval of $350,000 PDF C 12/16/96 12/16/96 GEF Council approval 04/30/97 05/01/97 Appraisal mission departure 10/20/97 10/20/97 Negotiations 01/12/98 01/12/98 GEF CEO Endorsement 02/28/98 Planned Date of Effectiveness 09/15/98 Prepared by: State Economic and Trade Commission (SETC) Preparation assistance: GEF Project Development Advances (US$700,000) B. Project Preparation and Schedule:Bank Critical Steps Time taken to prepare the project: 8 months First Bank mission (identification) 12/15/96 12/15/96 Appraisal mission departure 10/20/97 10/20/97 Negotiations 01/12/98 01/12/98 Planned Date of Effectiveness 09/15/98 Prepared by: State Economic and Trade Commission (SETC) Preparation assistance: None C. Bank staff who worked on the project included: Name Specialty R. Taylor Task Manager C. Husband Financial Analysis T. Johnson Economics S. Rivera Information Component T. Chang Operations Assistant C. Garstang Legal Note: Project budgeting data are in the project file. Page 62 ANNEX $ ANNEX 8: DOCUMENTS IN THE PROJECT FILE* A. Project Implementation Plan Including: * Beijing EMC Business Plan (October 1997) * Liaoning EMC Business Plan (October 1997) * Shandong EMC Business Plans (October and November 1997) * A Chinese Proposal to the GEF for a National Energy Efficiency Information Programme (October 15, 1997) * Technical Assistance Program Proposal (November 1997) * EMC Development Unit, activity outline (October 1997) B. Bank Staff Assessments - Financial Risk Analysis: The Case of Liaoning EMC C. Other * Draft Cost Report Format (tables) - Project Procurement Arrangements and Cost Details (January 1998) *Including electronic files Page 63 ANNEX 9 ANNEX 9: STATEMENT OF LOANS AND CREDITS A. STATEMENT OF BANK LOANS AND IDA CREDITS (As of January 31, 1998) Amount in US$ million Loan/ Fiscal (less cancellations) Closing Credit Year Borrower Purpose Bank IDA Undisb. Date Credits 70 Credits closed 4,790.66 22420 1991 HENAN AGRIC. DEVT. 110.00 3.23 6/30/98 22100 1991 KEY STUDIES DEVELOPM 131.20 0.83 6/30/98 22960 1992 SHANGH4AI METRO TRANS 60.00 3.76 6/30/98 23050 1992 DAGUANGBA-HAINAN 37.00 0.42 12/31/98 23070 1992 GUANGDONG AG. DEVT. 162.00 11.71 12/31/98 23360 1992 RURALWATSUPP&SAN 110.00 1.80 12/31/98 23120 1992 BEIJING ENVIRONMENT 80.00 3.70 1/31/99 23170 1992 INFECTIOUS DISEASES 129.60 54.86 6/30/99 23390 1992 EDUC DEV IN POOR PRO 130.00 4.07 12/31/98 23870 1992 TIANJIN URB DEV & EN 100.00 32.43 12/31/98 24110 1993 SICHUAN ADP 147.00 22.67 12/31/99 25180 1993 GRAIN DISTRIBUTION PROJ 165.00 59.76 6/30/00 24750 1993 ZHEJIANG MULTICITIES 110.00 47.43 6/30/99 24230 1993 FINANCIAL SECTOR T.A 60.00 35.57 9/30/99 24470 1993 REF. INST'L.& PREINVEST(CRISP) 50.00 21.64 6/30/98 24570 1993 CHANGCHUN WAT SUPP & 92.45 27.04 12/31/98 24620 1993 AGRIC. SUPPORT SERVICES 115.00 10.46 12/31/00 24630 1993 TAIHU BASIN FLOOD CONTROL 100.00 4.93 6/30/98 24710 1993 EFFECTIVE TEACHING SERVICES 100.00 48.39 12/31/98 25220 1993 ENVIRONMENT TECH ASS 50.00 15.22 12/31/98 25630 1994 RED SOILS II DEVELOP 150.00 49.04 6/30/01 25390 1994 RUR HEALTH MANPOWER 110.00 44.89 12/31/99 25710 1994 SONGLIAO PLAIN ADP 205.00 59.78 12/31/01 26050 1994 XIAOLANGDI RESETTLEMENT 110.00 44.33 12/31/01 26160 1994 LOESS PLATEAU 150.00 48.19 12/31/02 26230 1994 FOREST RESOURCE DEV 200.00 102.31 12/31/01 26540 1995 ECONOMIC LAW REFORM 10.00 6.03 6/30/99 27090 1995 FISCAL & TAX REF. & 25.00 17.79 12/31/99 27100 1995 YANGTZE BASIN WATER 110.00 9.48 12/31/01 27560 1995 IODINE DEF. DISORDER 20.00 11.40 12/31/98 26420 1995 ENT. HOUSING SOC. SE 75.00 6.22 6/30/01 27440 1995 SOUTHWEST POV. REDUC 200.00 105.95 12/31/01 26550 1995 MATERNAL CHILD HEALT 90.00 33.54 6/30/01 26510 1995 BASICEDUCINPOOR& 100.00 21.56 12/31/00 28000 1996 LABOR MARKET DEV. 20.00 15.65 12/31/99 28310 1996 BASIC ED. POOR III 100.00 43.29 12/31/01 27990 1996 HUBEI URBAN ENV. PRO 25.00 15.38 6/30/02 Page 64 ANNEX 9 Amount in US$ million Loan/ Fiscal (less cancellations) Closing Credit Year Borrower Purpose Bank IDA Undisb. Date 27940 1996 DISEASE PREVENTION 100.00 81.01 12/31/01 28920 1996 YUNNANENVIRONMENT 25.00 16.59 12/31/02 28340 1996 SHANXI POVERTY ALLEV 100.00 49.36 12/31/02 28700 1996 GANSU HEXI CORRIDOR 90.00 70.73 12/31/06 28860 1996 SEEDS SECTOR COMMER. 20.00 10.08 6/30/02 29540 1997 BASICED.IV 85.00 79.12 12/31/02 N0270 1997 NATL RUR WATER III 70.00 69.48 6/30/03 N0280 1997 QINBAMTS.POVTYRED 150.00 141.67 1/31/04 28980 1997 VOC. ED. REFORM PROJ 20.00 16.67 12/31/02 Total Number of Credits = 46 4,399.25 1,579.46 Loans 148 Loans(s) closed 7,527.63 73.37 2968S 1988 RAILWAY IV 171.30 2.04 6/30/98 3337T 1991 IRRIG. AGRIC. INTENS 45.06 2.37 3/31/98 3415A 1992 BEIJING ENVIRONMENT 32.90 29.32 1/31/99 3412S 1992 DAGUANGBA-HAINAN 28.89 2.83 12/31/98 3406A 1992 RAILWAYS V 33.73 29.05 12/31/98 3471A 1992 ZHEJIANG PROV TRANSP 70.13 26.59 6/30/98 3462A 1992 ZOUXIAN THERMAL POWE 26.78 14.02 6/30/99 3515A 1993 SHUIKOU II 43.86 18.40 6/30/98 3552S 1993 SHANGHAI PORT REST. 124.26 5.11 6/30/99 35820 1993 SO.JIANGSU ENVIRON. PROTECT. 250.00 29.16 6/30/01 3606A 1993 TIANHUANGPING HYDRO 196.60 102.89 12/31/01 3530S 1993 GUANGDONG PROV. TRANSPORT 240.00 21.43 6/30/99 35810 1993 RAILWAY VI 420.00 136.54 6/30/99 35310 1993 HENAN PROV. TRANSPORT 120.00 16.15 6/30/98 3560A 1993 TAIHU BASIN FLOOD CONTROL 88.65 64.71 6/30/98 3572A 1993 TIANJIN IND. II 82.68 56.09 6/30/00 3624A 1993 GRAIN DISTRIBUTION PROJ 325.00 325.00 6/30/00 3681A 1994 FUJIAN PROV HIGHWAY 80.33 65.32 6/30/00 3716A 1994 SICHUAN GAS DEV & CONSERV. 175.45 161.52 6/30/01 37270 1994 XIAOLANGDI MULTIPURPOSE 460.00 30.91 12/31/00 3687A 1994 TELECOMMUNICATIONS 132.76 101.49 6/30/99 37480 1994 HEBEI/HENAN NATIONAL H'WAYS 380.00 115.10 6/30/00 3711S 1994 SHANGHAI ENVIRONMENT 160.00 83.93 6/30/00 3652S 1994 SHANGHAI MTP II 150.00 10.39 12/31/98 3718A 1994 YANGZHOU THERMAL POWER 248.16 94.85 12/31/00 37880 1995 SHENYANG IND. REFORM 175.00 129.12 6/30/01 3846B 1995 ZHEJIANG POWER DEVT 215.67 187.82 12/31/02 3847A 1995 TECHNOLOGY DEVELOPME 194.99 181.87 6/30/01 38736 1995 FISCAL & TAX REF. & 25.00 25.00 12/31/99 3874A 1995 YANGTZE BASIN WATER 97.26 73.1 12/31/01 39066 1995 SOUTHWESTPOV. REDUC 47.50 35.89 12/31/01 3914A 1995 IODINE DEF. DISORDER 7.00 7.00 12/31/98 38976 1995 RAILWAYS VII 400.00 392.00 12/31/02 37810 1995 LIAONING ENVIRONMENT 110.00 79.53 6/30/01 Page 65 ANNEX 9 Amount in US$ million Loan/ Fiscal (less cancellations) Closing Credit Year Borrower Purpose Bank IDA Undisb. Date 3846A 1995 ZHEJIANG POWER DEVT 154.15 125.34 12/31/02 37870 1995 XINJIANG HIGHWAY I 150.00 95.75 12/31/00 B1050 1995 42.86 42.86 10/1/98 39106 1995 INLAND WATERWAYS 210.00 155.82 6/30/01 3848A 1995 SICHUAN TRANSMISSION 270.00 209.73 12/31/01 3773A 1995 ENT. HOUSING SOC. SE 262.51 240.11 6/30/01 3933A 1996 ERTAN HYDRO II 177.68 51.64 12/31/01 39290 1996 SHANGHAI-ZHEJIANG HI 252.25 155.78 6/30/01 40280 1996 GANSU HEXI CORRIDOR 60.00 60.00 12/31/06 3933B 1996 ERTAN HYDRO II 88.84 9.80 12/31/01 3967A 1996 LABOR MARKET DEV. 10.00 10.00 12/31/99 39860 1996 2ND SHAANXI PROV HWY 210.00 183.98 12/31101 39870 1996 SECOND SHANGHAI SEWE 250.00 219.29 6/30/02 40010 1996 ANIMAL FEED 150.00 150.00 12/31/02 40440 1996 SEEDS SECTOR COMMER. 80.00 80.00 6/30/02 B1060 1996 33.33 33.33 4/1/10 40450 1996 CHONGQING IND POL CT 170.00 170.00 12/31/02 40550 1996 YUNNAN ENVIRONMENT 125.00 125.00 12/31/02 39660 1996 HUBEI URBAN ENV. PRO 125.00 125.00 6/30/02 40270 1996 2ND HENAN PROV HWY 210.00 198.00 12/31/02 B1061 1996 16.67 12.92 4/1/10 40990 1997 XINJIANG HIGHWAYS II 300.00 268.81 12/31/02 41240 1997 HUNAN/GUANG HWY2-NH2 400.00 400.00 6/30/03 4063A 1997 VOC. ED. REFORM PROJ 10.00 10.00 12/31/02 41870 1997 QINBA MTS. POVTY RED 30.00 30.00 1/31/04 41610 1997 HEILONGJIANG ADP 120.00 117.00 6/30/03 42001 1997 XIAOLANGDI MULTI. II 200.00 191.84 12/31/03 41720 1997 TUOKETUO POWER/INNER 400.00 400.00 7/31/04 41790 1997 WANJIAZHAI WATER TRA 400.00 372.17 6/30/03 41970 1997 SHANGHAI WAIGAOQIAO 400.00 400.00 1/31/06 42000 1997 XIAOLANGDI MULTI. II 230.00 230.00 12/31/03 42370 1998 SHANDONG ENVIRONMENT 95.00 95.00 12/31/03 Total Number of Loans = 66 #0### 7,625.73 Total 18,519.88 9,189.91 of which repaid 2,023.03 75.32 Total held by Bank & IDA 16,496.84 9,114.59 Amount sold 0 of which repaid 0 Total Undisbursed 9,279.33 Page 66 ANNEX 9 B. STATEMENT OF IFC's COMMITTED AND DISBURSED PORTFOLIO (As of December 31, 1997, in US$ million) IFC Committed IFC Disbursed FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1987192/94 China Bicycles 8.50 3.39 0.00 0.00 8.50 3.39 0.00 0.00 1993 Shenzhen PCCP 3.76 .99 0.00 0.00 3.76 .99 0.00 0.00 1993 Yantai Cement 16.64 1.95 0.00 8.89 16.64 1.95 0.00 8.89 1994 China Walden JV 0.00 6.00 0.00 0.00 0.00 3.53 0.00 0.00 1994 China Walden Mgt 0.00 .01 0.00 0.00 0.00 .01 0.00 0.00 1994 Dalian Glass 20.50 2.40 0.00 40.50 20.50 2.40 0.00 40.50 1994 Dynamic Fund 0.00 12.35 0.00 0.00 0.00 9.46 0.00 0.00 1994 Plant. Timber 10.00 1.00 0.00 20.00 10.00 1.00 0.00 20.00 1995 DupontSuzhou 24.92 4.15 0.00 52.00 19.34 4.15 0.00 30.66 1995 Newbridge Inv. 0.00 10.00 0.00 0.00 0.00 6.60 0.00 0.00 1995 Suzhou PVC 22.00 2.48 0.00 22.20 0.00 2.48 0.00 0.00 1996 BeijingHormel 5.00 .50 0.00 5.50 4.64 .50 0.00 5.11 1996 Fairyoung Ports 0.00 4.98 0.00 0.00 0.00 4.98 0.00 0.00 1996 Jingyang 40.00 0.00 0.00 100.00 34.29 0.00 0.00 85.71 1996 NanjingKumho 16.00 3.81 0.00 45.50 13.63 3.81 0.00 38.75 1996 Tianjin Kumho 11.17 0.00 0.00 33.00 0.00 0.00 0.00 0.00 1996 Weihai Weidongri 4.13 0.00 0.00 0.00 4.13 0.00 0.00 0.00 1997 Rabobank PTPC 2.40 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1997 Orient Finance 10.00 0.00 0.00 20.00 3.33 0.00 0.00 6.67 Total Portfolio 195.02 54.01 0.00 347.59 138.76 45.25 0.00 236.29 Approvals Pending Commitment 1996 CALTEX Ocean 31.33 0.00 0.00 66.00 1998 Chengxin-IBCA 0.00 .36 0.00 0.00 1997 Chinefarge 12.80 0.00 0.00 20.00 1997 DerKwei Overseas 0.00 5.00 0.00 0.00 1997 DerKwei Shanghai 13.00 0.00 0.00 38.00 1997 DerKwei Shenzhen 12.00 0.00 0.00 33.00 1998 Eureca 0.00 3.00 0.00 0.00 1997 Liaocheng Jiamin 18.00 0.00 0.00 18.00 1996 Nanjing Huining 4.00 0.00 0.00 0.00 1997 Ningbo 0.00 2.00 0.00 0.00 1997 Nissan/Dongfeng 20.20 0.00 0.00 27.00 1997 PTP Holdings 0.00 1.50 0.00 0.00 1997 PTP Hubei 13.00 0.00 0.00 25.00 1998 PTP Hubei BLINC 0.00 0.00 0.00 1.50 1997 PTP Leshan 4.20 0.00 0.00 0.00 1998 ScanaLeshan 6.10 1.35 0.00 0.00 1996 Shandong Sand 17.00 0.00 0.00 25.00 1998 Shanghai Coline 13.00 0.00 0.00 0.00 1997 SMC 14.00 0.00 0.00 14.00 1997 Suzhou PVC Add. 7.90 0.00 0.00 6.40 1996 Tianjin 9.10 0.00 0.00 9.10 1996 Xiamen Xian 10.00 0.00 0.00 0.00 Total Pending Commitment 205.63 13.21 0.00 283.00 Page 67 ANNEX 10 ANNEX 10: COUNTRY AT A GLANCE POVERTY and SOCIAL East Low. China Asia income Development dlamond Population mid-1996 (millions) 1,215.4 1,726 3,229 GNP per capita 1996 (USS) 750 890 500 Life expectancy GNP 1996 (billions US$) 906.1 1,542 1,601 Average annual growth, 1990-96 Population (%) 1.1 1.3 1.7 GNP Gross Laborforce (%) 1.1 1.3 1.7 per primarY Most recent estimate (latest year available since 1969) capita enrollment Poverty: headcount index (% of population) 9 Urban population (% of total population) 31 31 29 | Life expectancy at birth (years) 70 68 63 Infant mortality (per 1,000 live births) 33 40 69 Access to safe water Child malnutrition (% of children under 5) 16 Access to safe water (% of population) 90 49 53 Illiteracy (% of population age 15+) 19 17 34 China Gross primary enrollment (% of school-age population) 118 117 105 Male 119 120 112 Low-income group Female 117 116 98 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1975 1985 1995 1996 Economic ratios' GDP (billions USS) 160.3 378,1 755.9 916.4 Gross domestic investment/GDP 30.3 37.8 40.5 42.4 Openness of economy Exports of goods and services/GDP 5.2 9.9 21.0 18.5 Gross domestic savings/GDP 30.6 33.7 42.0 43.9 Gross national savings/GDP 30.6 34.0 40.5 43.1 Current account balance/GDP -0.2 -3.9 0.2 0.4 Interest payments/GDP .. 0.2 0.7 0.6 Savings l-- Investment Total debtUGDP ,. 5.5 16.9 15.8 Total debt servicelexports .. 8.4 9.9 9.8 Present value of debUGDP .. .. .. 14.3 Present value of debt/exports .. .. .. 72.3 Indebtedness 1975-85 1986-96 1995 1996 1997-05 (average annual growth) ; China GDP 8.3 9.9 10.5 9.7 8.5 GNP per capita 7.5 8.4 7.9 8.8 76 Low-income group Exports of goods and services 17.2 13.4 9.6 7.4 8,6 STRUCTURE of the ECONOMY 1975 1985 1995 1996 G8 owth rates of output and Investment (% of GDP) Agriculture 32.0 28.4 20.6 20.0 25 - Industry 42.8 43.1 48.4 48.9 20 Manufacturing 31.6 35.4 37.6 38,9 15 Services 25.2 28.5 31,1 31.1 lo Private consumption 61.9 53.1 45.7 44.9 91 92 93 94 95 9F General government consumption 7.6 13.2 12.2 11.2 GDI - DP Imports of goods and services 5.0 14.0 19.4 17.0 - 1975-85 1986-96 1995 1996 (average annual growth) Growth rates of exports and Import Agriculture 5.4 4.3 5.0 5.1 40 Industry 10.4 13.5 14.1 12.3 Manufacturing 13.0 12.7 13.3 12.3 20. Services 9.8 8.9 7.9 7.9 Private consumption 8.2 8.6 6.3 3.3 o - -'-,--. ,- General government consumption 9.0 10.2 .. 11.4 , 01 92 93 94 95 90 Grossdomesticinvestment 9.8 10.1 19.1 16.6 , -20 Imports of goods and services 22.1 11.1 5.0 8.6 Exports I tnports Gross national product 9.0 9.8 9.0 9.9 Note: 1996 data are preliminary estimates. Figures in italics are for years other than those specified. The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete. Page 68 ANNEX 10 China PRICES and GOVERNMENT FINANCE 1T 19B5 1995 1996 -- - - - Domestic prices Inflation(% (% change) 30. Consumer prices .. 9.2 17.1 8,3 Implicit GDP deflator -0.9 10.1 13.1 6.1 20 Goverrnment finance l (% of GDP) 0 Current revenue .. 25.5 11.2 11.4 91 92 93 94 55 56 Current budget balance .. 6.7 0.5 0.6 - GDPdef. --O--CPI Overall surplusldeficit .. -0.5 -1.7 -1.5 TRADE 1975 1985 1995 1995 __ (millions US$) Export and import levels (mill. USS) Total exports (fob) .. 27,350 148,770 151,073 200.0 Food .. 3,803 9,954 10,232 Fuel .. 7,132 5,335 5,929 1rooxax Manufactures .. 13,522 127,283 129,141 ( Total imports (cif) .. 42,252 132,078 138,828 100 000 Food .. 1,881 9,128 7,8866I Fuel and energy .. 172 5,127 6,877 5000 Capital goods (18=0)18,694 57,481 83,901 ;fI i Export prc.ndx.98=0 92 133 132 90 91 92 93 94 99 96 Import price index (1987=100) .. 78 132 131 Exprt [ Imports Terms of trade (1987=l00) .. 118 101 100 BALANCE of PAYMENTS 1975 1985 1998 1995 ______ (millions US$) ICurrent account balance so GDP ratio(% Exports of goods and services 7,828 28,163 147,240 153,740 4 Imports ofgoods and services 8,097 41,149 135,284 141 340 Resource balance -289 -12,986 11,956 12,400 Net income 0 932 -11,774 -10,370[ -- Net current transfers 0 171 1.400 1,580 Current account balance, 90 51 92 93 94 95 90 before official c-apital transfers -289 -11,883 1,582 38610 2 Financing items (net) .. 9,443 20,887 28,030 Changes in net reserves .. 2,440 -22,489 -31,640 -4 Memo: _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ Reserves including gold (mill. US$) .. 16,853 80,312 1 11,690 Conversion rate (Iocal/US$) 1.9 2.9 8.4 8.3 EXTERNAL DEBT and RESOURCE FLOWS 1975 1985 1995 1996 (millions US$) Composition of total debt, 1996 (mill. US$) Total debt outstanding and disbursed .. 16,896 118,090 128,817 IBRD . 498 7,209 7.616 GA 6 IDA .. 431 7,038 7,579 25407 7616759) Total debt service .. 2,478 15,066 15,756 / 20 IBRD . 26 810 840/ IDA .. 4 63 73 E..213 Comnposition of net resource flows Official grants .. 117 328 248 Official creditors .. 1,117 7,902 4,359 Private creditors .. 2,867 5.013 6,454 Foreign direct investment .. 1,659 35,6349 40,180 Portfolio equity .. 0 2,807 3,466 .F 63977 World Bank program Commitmnents . 1,092 2,850 1.900 A - IBRD E6- Bilateral Disbursements .. 565 2,269 2,097 .3 I- IDA D0- Other multilateral F - Private Principal repayments .. 0 364 364 C - IMF G - Short-term Net flows . 565 1,905 1,734 - Interest payments .. 29 509 549 Net transters .. 536 1.396 1,185 Development Economics 1/29198 Note: The dollar estimates for China's GNP per capita, GNP and GOP are preliminary figures based on an on-going World Bank study of China's GOP, They were calculated to facilitate inter-country comparisons. Official statistics are used as the basis for all other economic analysis containedi in this document.