China - Sichuan Gas Development & Conservation

 ICRR 11706 Report Number : ICRR11706 ICR Review Operations Evaluation Department 1. Project Data: Date Posted : 03/24/2004 PROJ ID : P003609 Appraisal Actual Project Name : Sichuan Gas Dev & Project Costs 877.9 902.8 Conservation US$M ) (US$M) Country : China Loan /Credit (US$M) Loan/ US$M ) 255.0 208.9 Sector (s): Board: EMT - Oil and gas Cofinancing 10 10 (100%) US$M ) (US$M) L/C Number : L3716 Board Approval 94 FY ) (FY) Partners involved : UNDP, Japan Grant Trust Closing Date 06/30/2001 06/30/2003 Fund, Global Environment Facility (GEF) Prepared by : Reviewed by : Group Manager : Group : Robert C. Varley Roy Gilbert Alain A. Barbu OEDST 2. Project Objectives and Components a. Objectives The development objectives (a.- c.) and the global environment objectives (d.- f.) were to: a. Support the restructuring of the Borrower's upstream oil and gas sector (implementing the first phase of restructuring to include rationalization of pricing /allocation, commercialization and corporatization, diversification of ownership and finance, introduction of a commercial accounting system, implementation of productivity enhancement and human resource development programs .) b. Promote the development and conservation of gas resources in an economic, efficient and environmentally sound manner. c. Strengthen the institutional capabilities of China National Petroleum Company (CNPC) and Sichuan Petroleum Administration (SPA.) d. Assist the Recipient in its efforts to reduce methane emissions . e. Enhance the operational efficiency and safety of gas transmission and distribution . f. Strengthen the institutional capabilities of the operating agency (SPA.) There was an overlap between the development and global objective, with (d-f) explicitly introduced to support the GEF (Global Environment Facility) goals, by targeting safety and environmental outcomes (reduction of the major greenhouse gases, CO 2 and methane.) b. Components At appraisal the component base costs totalling $ 877.8 million were: 1. Oil and Gas Sector Restructuring - commercialization and corporatization of CNPC and the SPA, introduction of a commercial accounting system, productivity enhancement and related human resource development . 2. Investment Component (98%) 98 %) - development of 100 wells in 14 proven gas fields, surveys, interpretation and construction of surface facilities; rehabilitation of 190 wells and environmental upgrade of the gas transmission and distribution system. 3. Institutional Development (2%) - technical assistance and training for components 1 and 2, national education programs to upgrade teaching and research capabilities in petroleum institutes, and development of exchange programs with foreign institutes for knowledge transfer . The ICR compared appraised/actual cost by more specific functional components : Gas Fields Development - 56.8 % / 68.6% Dehydration and Desulfurization - 7.3% / 3.7% Fields Stimulations and Rehabilitation - 13.1% / 5.9% Gas Transmission Expansion - 8.4% / 7.2% Gas Transmission Rehabilitation - 9.5% / 11.2% Gas Transmission Environment Upgrade - 2.8% / 1.7% Technical Assistance and Training - 2.1% / 1.7% c. Comments on Project Cost, Financing and Dates The global environment objectives were supported by a $ 10 million grant from the Global Environment Trust (GET) administered by GEF. An additional $3 million in project preparation costs were financed by grants from the Japanese Grant Facility, UNDP and GEF's pre -investment facilities. Domestic funding from the SPA, CNPC and PetroChina China Ltd (PCL) was 76.6% of final project costs. Completion was delayed by two years, largely as a result of procurement difficulties and the restructuring of CNPC and SPA in 1999. Additional funds from issuing equity reduced loan requirements and $ 37.9 million of the IBRD loan was cancelled and $ 8.2 million remained undisbursed. Technical services costs for exploration /rehabilitation and gas-distribution/transmission are not disaggregated. Over two thirds of the actual project cost is accounted for by gas fields development, significantly more than anticipated at appraisal . 3. Achievement of Relevant Objectives: Development Objectives : a. Restructuring of the upstream gas sector was largely achieved . Core CNPC activities were consolidated into PCL. PCL-Southwest Oil & Gas Fields Company took over SPA's core functions and SPA retained non -core activities and continued as a state owned enterprise (SOE.) As part of the privatization process an offer of 10% of PCL shares ($2.5 billion) were successfully raised on the international market and foreign investors entered partnerships with other non PCL upstream producers . Transparency in the separation of Government from Enterprise Management was achieved by relieving government agencies of responsibilities for all but policy making, regulatory formulation and long -term planning. Responsibility for all aspects of safety administration was assigned to the State Administration for Safety Supervision in 1999; however, the recent major accident in Kaixian (see section 5 below) appears to point to continued deficiencies in the enforcement of safety regulations. b. Expansion of gas production in an economically and environmentally sound manner was largely achieved - appraisal indices of the Field productivity increased by the targeted 10-30%) - the 10 billion cubic meter (BCM) production achieved by 2000 was 25% above target. The expansion of the pipeline gas transmission capacity from 6.5 bcm to 10 bcm was accomplished in an environmentally sound manner, and gas quality brought into compliance with safety rules. Entry of non-specification gas has been eliminated from the system and reduction of CO2 and methane emissions exceeded, achieving important global environment objectives . The WTO agreements prohibit the subsidies sustaining inefficient production and they are due to be phased out . Physical and production targets were exceeded, but improvements in allocative efficiency could have been greater . Gas production is still allocated to SOEs by the State - the old policy is being phased out more slowly than expected at appraisal, especially to the fertilizer industry . Neither do gas prices incorporate positive environmental externalities. SAR baseline indicators and targets for the increasing effectiveness of energy conservation activities, by introducing sound reservoir management and application of new technology to gas recovery, were not evaluated at completion. c. Institutional capabilities of SPA and PCL were enhanced through training, consultancy and studies . Improvements in operational efficiency, accountability and coordination were less than anticipated due to the administrative separation of Chongqing municipality from Sichuan Province . Long-term sustainability was enhanced by a collaboration agreement with the French natural gas engineering contractor SOFREGAZ, replacing discrete short-term technical assistance packages . Updated baseline indicators for breakdowns, accidents and gas leakages, although listed in the SAR, were not available to evaluate the field environment while capacity to manage to safety standards still appears suboptimal (see below) d. Methane emissions were reduced from 3.7% to 0.43%. This objective was fully achieved . e. Operational efficiency and safety of gas transmission and distribution were improved in most respects f. Institutional capabilities of the operating agency were improved through reorganization and project implementation experience, as well as the introduction of modern management systems, and monetary incentives. However, compliance with safety procedures and standards appears suboptimal in some areas, as shown by the recent Kaixian accident (see section 5 below) The economic rate of return (ERR) of the project was 24%, equal to the ICR estimate, and exceeded 70% with alternative shadow pricing assumptions . Both global and local environmental benefits of reduced methane / CO2 emissions, and substitution of clean gas -fired power generation for coal, would have increased the ERR further . The financial rate of return (FIRR) of 13% exceeded the SAR's 12%, higher capital and operating costs being offset by increased production, sales and price . 4. Significant Outcomes/Impacts: State of the art technologies, helped PCL Southwest exceed both exploration and production targets . Sichuan's natural gas resource grew to 682 billion cubic meters (bcm), 32% of China's 1999 proven gas reserves. The project had a substantial institutional development impact through increased technical capacity . Project experience was an important input to the National Gas Law, currently under consideration by the People's Congress. Indirectly, the project facilitated development of gas -fired power generation in a neighboring province - plans include building a pipeline to deliver Sichuan gas to supply power plants in Hubei . Decreased methane emissions and net reduction of CO 2 by energy using sectors substituting for coal, made a significant contribution to achieving China's commitments to reducing global warming . 5. Significant Shortcomings (including non-compliance with safeguard policies): 1. A major recent accident appears to indicate that critical safety systems have been ineffective and best practices  not yet been implemented in at least some areas of operation, raising doubts about adequacy of implementation of the environmental action plan (section 5.0 related to well-site safety) agreed with the Bank. In December 2003 (shortly after the completion of the ICR ), a well-head explosion in Kaixian county led to 4 CNPC staff fatalities and the death of another 240 villagers by hydrogen sulfide asphyxiation over a 12 hour period. Although there has not yet been any final verdict on the causes of the accident, an inquiry by the State Administration for Safe Production Supervision, reported in the Peoples Daily in January 2004, blamed the consequences of the explosion on negligence, poor disaster response and inadequate CNPC supervision . Reportedly, the affected well had not been subject to a mandatory environmental impact assessment, and was located 20-30 meters from homes, instead of the minimum of 1 kilometer required by regulations; also, public information systems were reportedly inadequate and disaster response seriously delayed . 2. Project interactions with the province's environmental bureaux and the CNPC /PCL environment divisions, gave too much influence to provincial priorities, and not visibly to national environmental policy dialogue . 6. Ratings : ICR OED Review Reason for Disagreement /Comments Outcome : Satisfactory Satisfactory However, there are some doubts about how much critical safety systems have been improved, especially those for well-siting and disaster recovery, in light of the Kaixian accident (see section 5) Institutional Dev .: Substantial Substantial Sustainability : Highly Likely Highly Likely Bank Performance : Satisfactory Satisfactory Borrower Perf .: Satisfactory Satisfactory However, Borrower performance on safety aspects appears to have been suboptimal in some areas Quality of ICR : Satisfactory NOTE ICR rating values flagged with ' * ' don't comply with OP/BP 13.55, but are listed for completeness. NOTE: 7. Lessons of Broad Applicability: The transition to market-based production systems has to be both managed and regulated to ensure that critical safety rules are adequately complied with and enforced . Additional supportive measures are needed to ensure a reduction of adverse environmental and health impacts from coal use, and Bank projects with this objective should include covenanting the closure of specific high-polluting thermal generating plants . The full benefits of efficient resource pricing will only be achieved when the pricing of substitutes is also rationalized. A long-term collaboration with a leading international gas services contractor has proved preferable to a series of shorter donor financed technical assistance inputs . 8. Assessment Recommended? Yes No Why? In light, inter alia, of safety issues raised by the Kaixian Disaster . 9. Comments on Quality of ICR: Satisfactory - the ICR is clearly presented but assumptions underlying the evaluation of economic benefits, when there is a sustained excess demand in the power sector, are not explained nor made explicit . Outcome rating is heavily influenced by high ERR but the latter hinges on assumptions about the substitutability between gas and coal as electricity sector inputs .