China - Follow-up Project to the First Phase of the Renewable Energy Scale-Up Program

Document of The World Bank FOR OFFICIAL USE ONLY Report No: 33018-CN PROJECT APPRAISAL DOCULMENT ON A PROPOSED LOAN IN THE AMOUNT OF US$86.33 MILLION TO THE PEOPLE'S REPUBLIC OF CHINA FOR THE FOLLOW UP PROJECT TO THE FIRST PHASE OF THE CHINA RENEWABLE ENERGY SCALE-UP PROGRAM January 5,2006 Energy and M[ining Sector Unit Infrastructure Unit East Asia and Pacific Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (Exchange rate effective September 1, 2005) Currency unit = Renminbi yuan 1 yuan = US$0.12 1 U.S. dollar = Y 8.09 FISCAL YEAR January 1 - December31 ACRONYMS AND ABBREVIATIONS APL Adaptable Program Loan NDRC National Development and Reform CAS Country Assistance Strategy Commission CER Carbon Emission Reductions NUPG Northem Union Power Group CRESP China Renewable Energy Scale-up IMNLYWPC Inner Mongolia North Long Yuan Program - Phase 1 (Loan 4792-CHA) Wind Power Company dBa Decibel (filter characteristic curve a) OECD Organization for Economic ELA Enviromnental impact assessment Cooperation and Development EIRR Economic intemal rate of return CF Carbon Fund EMP Environment management plan PDO Project Development Objective ERPA Emission Reduction Purchase Agreement PIP Project Implementation Plan FIRR Financial internal rate of return PIU Project Implementation Unit FYP Five-Year Plan PPA Power Purchase Agreement FMS Financial Management Specialist PMO Project Management Office GDP Gross domestic product PPO Provincial Project Office (Zhejiang) GEF Global Environment Facility RAP Resettlement Action Plan GHG Greenhouse gas RE Renewable energy GoC Govermnent of China REDP Renewable Energy Development GTZ Deutsche Gesellschaft fur Technische Project (Loan 4488-CHA) Zusanuenarbeit REL Renewable Energy Law GW Gigawatt (1,000 megawatts) SIL Specific investment loan GWh Gigawatt hour TA Technical Assistance ICB Intemational Competitive Bidding TSP Total Suspended Particulates IPP Independent power producer TW Terawatt (1,000 GW) LSDP Letter of Sector Development Policy TWh Terawatt hour MBD Model Bidding Document UNEP United Nations Environment P nogman MMP Mandated market policy VSL Variable spread loan MOF Ministry of Finance ZFB Zhejiang Finance Bureau Mtce Million tons of coal equivalent ZHPMDC Zhejiang Hydro Power Management (1 tce = 29.3 Gigajoules) Development Center MW Megawatt (1,000 kilowatts) MWh Megawatt hour Acting Vice President: Jeffrey Gutman Country Manager/Director: David Dollar Sector Manager: Junhui Wu Task Team Leader: Noureddine Berrah  FOR OFFICIAL USE ONLY CHINA Follow up Project to the First Phase of the China Renewable Energy Scale-up Program CONTENTS Page A. STRATEGIC CONTEXT AND RATIONALE ................................... , . , . 1 1. Country and Sector Issues ........................... .. 1 2. Rationale for Bank Involvement .4 3. Higher-Level Objectives to Which the Project Contributes .4 B. PROJECT DESCRIPTION ...................... . . . . .. . . . . 4 1. Lending Instrument .......................................I ., , , . , . , . 4 2. Project Development Objective and Key Indicators ..................................... , . 5 3. Project Components .5 4. Lessons Leamed and Reflected in the Project Design .....................................,. 6 5. Alternatives Considered and Reasons for Rejection .7 C. IMPLEMENTATION .................. . ... . 7 1. Institutional Development and Implementation Arrang e ments .7 2. Monitoring and Evaluation of Outcomes and Results ......................................,,.9 3. Sustainability and Replicability .9 4. Critical Risks and Possible Controversial Aspects .9 5. Loan Conditions and Covenants .11 D. APPRAISAL SUMMARY .................... 11 1. Economic and Financial Analyses .11 2. Technical.. 12 3. Fiduciary ....... 13 4. Social .13 5. Environment ........... 13 6. Safeguard Policies ........... 13 7. Policy Exceptions and Readiness .14 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.  Annex 1: Country and Sector or Program Background ..................... .......................... 15 Annex 1A: Letter of Sector Development Policy, NDRC .............................................. 23 Annex 3: Results Framework and Monitoring ............................................... 28 Annex 4: Detailed Project Description .............................................. 30 Annex 5: Project Costs ............................................... 34 Annex 6: Implementation Arrangements ............................................... 35 Annex 7: Financial Management and Disbursement Arrangements ........................................... 38 Annex 8: Procurement Arrangements ............................................... 42 Annex 9: Economic and Financial Analysis ............................................... 47 Annex 10: Safeguard Policy Issues ............................................... 53 Annex 11: Project Preparation and Supervision ............................................... 57 Annex 12: Documents in the Project File ............................................... 59 Annex 13: Statement of Loans and Credits ............................................... 61 Annex 14: Country at a Glance ............................................... 66 Annex 15: Carbon Finance ............................................... 68 Annex 16: Maps ............................................... 71 Maps IBRD 34208 IBRD 34209  CHINA Follow up Project to the First Phase of the China Renewable Energy Scale-up Program PROJECT APPRAISAL DOCUMENT East Asia and Pacific Region EASEG Date: January 5, 2006 Team Leader: Noureddine Berrah Country Director: David R. Dollar Sectors: Renewable energy (100%) Sector Manager/Director: Junhui Wu Themes: Infrastructure services for private Project ID: P096158 sector development (P); environmental policies Lending Instrument: Specific Investnent Loan and institutions (P); climate change (P); trade facilitation and market access (S); rural services and infrastructure (S) Environmental screening category: Partial Assessment Safeguard screening category: S2 [R] Loan 1 Credit D Grant O Guarantee 1 Other: For Loans/Credits/Others: Total Bank financing (US$ million): 86.33 Pro osed terms: VSL, 20 years maturity, five years' grace R Xw~~~~~01 BORROWER/RECIPIENT 28.33 1.75 30.08 INTERNATIONAL BANK FOR 0.00 86.33 86.33 RECONSTIRUCTICON AND DEVELOPMENT LOCAL FINANCIAL INTERMEDIARIES 16.01 0.00 16.01 Total: 44.33 88.08 132_42 Borrower: People's Republic of China Responsible Agency: National Development and Refonn Commission SH,,$a Sg' 'u kiea , BY 2006 2007 2008 2009 2010 _ _ Annual 7.80 26.02 18.90 17.06 16.56 _ Cunulative 7.80 33.81 52.71 69.77 86.33 _ L Project implementation period: Start: April 3,2006 End: March 31, 2010 Expected effectiveness date: March 31, 2006 Expected closing date: September 30, 2010 Does the project depart from the CAS in content or other significant respects? C Yes x No Ref: PAD A.3 Does the project require any exceptions from Bank policies? 1 Yes IZi No Ref; PAD D.7 Have these been approved by Bank management? 1 Yes a No Is approval for any policy exception sought from the Board? 12 Yes 12 No  Does the project include any critical risks rated "substantial" or "high"? 1 Yes El No Ref PAD C.5 Does the project meet the Regional criteria for readiness for implementation? Ref. PAD D. 7 1 Yes O No Project development objective Ref; PAD B.2, Technical Annex 3 The project development objective is to demonstrate early success in large-scale renewable energy investments with participating local developers in one pilot autonomous region and one pilot province. Project description Ref PAD B.3.a, TechnicalAnnex 4 Construction of a 100 MW wind farm at Huitengxile, Inner Mongolia; rehabilitation of eleven small hydropower plants to replace and increase the existing from about 40 to about 52 MW and construction of seven new small hydropower plants totaling about 16 MW in Zhejiang Province. Which safeguard policies are triggered, if any? Ref PAD D.6, Technical Annex 10 Environmental Assessment (OP/BP 4.01), Involuntary Resettlement (OP/BP 4.12), Safety of Dams (OP/BP 4.37) Significant, nonstandard conditions, if any, for: Ref. PAD C. 7 Board presentation: None Loan/credit effectiveness: None Covenants applicable to project implementation: Technical and financial reporting, financial performance, maintenance of a project company in Inner Mongolia and a project implementation unit in Zhejiang.  A. STRATEG][C CONTEXT AND RATIONALE 1. Country and Sector Issues China's primary energy consumption more than doubled from 600 million tons of coal equivalent (Mtce) in 1980 to about 1,300 Mtce in 2000, whereas the gross domestic product (GDP) quadrupled during the same period. Although based on slightly different growth assumptions, studies carried out in the late 1990s and early 2000s by the Government of China (GoC) and international agencies concluded that even in the case of increased and sustained energy efficiency efforts, energy consumption will continue to grow -rapidly to between 1,850 and 2,150 Mtce in 2010 and to between 2,500 and 3,300 Mtce in 2020.1 They also concluded that even with an aggressive fuel diversification policy, coal will remain the dominant energy source. As did most of the studies, the one by the Chinese Energy Research Institute found that coal's share in primary energy consumption, which accounted for 66 percent in 2000, would decrease only slightly to about 65 percent by 2010, and less than 60 percent in 2020 even if exceptional efforts were made in diversifying primary energy sources and improving overall energy efficiency (the "green scenario"). Under business as usual, coal's share in primary energy consumption would decrease to about 63 percent in 2020. Evidence from actual energy consumption during 2000 to 2004 indicates that these and other studies have underestimated primary energy consumption growth. Primary energy consumption has soared from 1,300 Mtce in 2000 to more than 1,700 Mtce in 2004, or 80 to 95 percent of the low and high studies' forecasts for consunaption in 2010. About 50 percent of the coal consumed in 2004 was used for electricity generation. China's electric generating capacity is projected to increase from a little less than 400 GW in 2004 to between 950 and 1,100 GW by 2020. During this same period, coal-based electric generation capacity is expectecl to grow threefold to about 700 GW. This will require building about 500 to 650 GW of coal-based capacity (in the case of the more likely high growth, about 450 GW to meet the fast-growing demand and about 200 GW to replace existing capacity). Coal-based generation will remain the predominant mode of electricity generation well beyond 2020. The damage caused by SO2 and NO. emissions to agriculture and health is at the center of the debate on the 1 ltb Five-Year Plan and the long-term energy plan (China 2020). Estimates of the costs vary, according to existing studies, from 3 to 7 percent currently and could grow to as high as 13 percent of GDP in 2020 if environmental issues are not properly addressed. Emissions of carbon from coal combustion will also increase from about 820 million tons in 2000 to more than 1.1 billion tons in 2010 and more than 1.8 billion tons in 2020 even with sustained efforts in energy efficiency and fuel diversification. Even then, China's carbon dioxide (CO2) emissions Four studies of particular relevance are (a) "Basic Concepts of the National Energy Strategy" 2004- Unpuablished draft by the Development Research Center based on a study by the Chinese Energy Research Institute presented during a workshop entitled "China Development Forum: China's National Energy Strategy and Reform," Beijing November 15-17, 2003; (b) World Energy Outlooks 2002 and 2004, International Energy Agency;, and (c) International Energy Outlook 2004-Energy Information Administration, Office of Integrated Analysis and Forecasting, US Department of Energy. 1  per capita would amount to only 20 to 30 percent of the Organization of Economic Cooperation and Development (OECD) countries in 2010 and 2020, respectively. China's highest-level authorities recognize that a business-as-usual approach in the energy sector would lead to unacceptable environmental damages. They recently adopted a multipronged energy strategy aiming at (a) improving the efficiency of the energy sector and bringing energy intensity in line with international best practice; (b) increasing gas penetration and aggressively developing renewable energy use, especially for power generation; (c) further developing clean coal technologies; (d) initiating research programs on coal to liquids and bioftiels and (e) securing energy supply to meet the country's growing needs. Chinese authorities recognize the vital need to pursue vigorously each prong of the strategy and to rely more on market-based approaches to achieve the higher-level objectives of sustainable development and a "well-off' society. Renewable Energy Strategy Scaling-up of renewable energy for electricity generation in particular will require a shift from off-grid and demonstration approaches to increased commercialization of high-potential technologies. China has abundant undeveloped resources of small hydropower, wind, biomass, geothermal, and solar energy. Exploitation of these resources has been constrained by an inadequate legal and regulatory framework, high costs of renewable-based electricity generation, insufficient assessment of the resource, and lack of or inadequate financing. Creation of an adequate legal and regulatory framework, cost reductions, and internalization of fossil fuel externalities and capacity building to improve design, construction, and operation to improve competitiveness with fossil fuel-based generation are all needed. The Government of China (GoC) has, with Global Environment Facility (GEF) and other donor assistance, prepared a Renewable Energy Law (REL) that was approved by the Standing Committee of the National People's Congress on February 28, 2005. Studies and consultation activities supported by the Bank and GEF introduced the concept of law- and regulation-based, market-oriented support for renewable energy. Such support addressed three critical barriers to renewable-based electricity generation: (a) the financial prices of fossil fuel- (especially coal-) based electricity generation do not reflect the costs of environmental damage; (b) the resulting incremental financial cost of renewable-based electricity cannot be passed on to the end consumer; and (c) renewable electricity generators are often unable to obtain access to the electricity grid on the same terms as other generators. The REL introduces a mandated market policy (MMP) which mandates that either a share of the electricity delivered to end consumers by power companies comes from renewable sources or imposes an obligation on power companies to buy renewable energy-based electricity at a government-determined price. Concomitant with that obligation are the rights of the power companies to recover the additional cost from consumers and for electricity generators to be able to connect to the grid. 2  China Renewable Energy Scale-up Program The First Phase of the China Renewable Energy Scale-up Program (CRESP: Loan 4792-CHA) was approved by the World Bank on June 16, 2005. The program objective is to enable commercial renewable energy suppliers to provide energy to the electricity market efficiently, cost-effectively and on a large scale. The GEF program was justified by the long-term and complex nature of the policy issues hampering the scale-up of renewable energy and the need for a flexible approach ito adapt to the fast-changing environment and the priorities as they emerge during implementation. As part of the first phase of CRESP preparation, economic, financial and fiscal analysis was carried out to evaluate the impact of various MMP options. The a-nalyses established that substantial additionaLl quantities of renewable energy were economically and financially viable. Under the base case an additional 89 TWh of electricity, equivalent to about 17.5 GW of capacity, was found to be economically viable, on the assumptions used in the analysis. Fiscal impact on local and provincial govermment was determined to be small, with a discounted gain of about $100 million to provincial and local governments from increased taxes being paid to provincial and local governments. The core of the program is GEF-financed support for institution and capacity building for the scale-up of renewable energy based electricity generation capacity. The first phase focuses on three pilot provinces, Fujian, Jiangsu and Zhejiang and one autonomous region, Inner Mongolia. The GEF finances a major effort to transfer technology and develop local manufacturing capacity for wind- and biomass-based power generation as a means to bring down the cost of electricity generation. It provides financing for supporting activities to foster further renewable energy developmenlt including resource evaluation and pre-investment activities. The key indicators for CRESP are explicitly tied to the program objectives and the extent to which the market framework and environment is improved for large scale renewable energy investments in Fujian, Inner Mongolia, Jiangsu and Zhejiang. Continued engagement of concerned agencies through the institution and capacity building component under CRESP do much to mitigate the risks associated with individual investment projects. Nonetheless, in parallel with the GEF program, CRESP also supports investment scale up by financing specific investments. A first loan was approved at the same time as the GEF grant on June 16, 2005 to finance a 100 MW wind project at Pingtan Island in Fujian Province and a 25 MW biomass combustion project at Rudong in Jiangsu Province. The loan proposed below would finance a 100 MW wind project at Huitengxile in Inner Mongolia Autonomous Region and rehabilitation and development of small hydro plants in Zhejiang Province. Further details on thte sector background and on CRESP are provided in Annex 1 and the GoC's program for development of the renewable energy subsector is set out in a letter from a Vice Chairman of the National Development and Reform Commission (NDRC), which is reproduced in Annex 1A. 3  2. Rationale for Bank Involvement The framework for scale-up is being put in place under the first phase of CRESP, but will take some time to take effect. During that period, furthe lending for scale up is needed, because investment funds from other, local, sources will take time to materialize. The continued involvement of the Bank through additional renewable energy inivestments in the pilot provinces will increase the prospects for the successful introduction of the MMP and the accompanying technology transfer and knowledge upgrade needed for the successful and sustained scaling-up of renewable energy use in China. The Bank's sustained engagemnent within the programnmatic approach approved by the GEF Council and the Board will facilitate the implementation of the strategy and sustain the scaling-up through support and leverage of investmnent in renewable energy-based electricity generation. Annex 2 provides information on related projects and the lessons learned from them. 3. Higher-Level Objectives to Which the Project Contributes The most recent full Country Assistance Strategy (CAS), discussed by the Board on December 19, 2002 (Report No. 25141-CHA), focuses on supporting China's sustainable transition from a rural to an urban society and from a centrally planned to a market-based economy. An important themne within the GAS is to facilitate an environmentally sustainable development process, focusing, amnong others, on global environment and air quality issues. Increased market-based electricity generation from renewable energy sources will contribute to achieving these objectives. The project is also fully in line with the goals of the CAS under preparation, to be presented to the Board during the third quarter of 2006 fiscal year. T'he proposed project contributes to the CAS objectives as well as the CRESP objective. More significant penetration of renewable energy resources will also contribute to increased security of supply and more predictable prices for electricity. B. PROJECT DESCRIPTION 1. Lending Instrument The proposed Bank specific investment loan (SIlL) fur-ther supports the first phase of CRESP described in section 1 above. Other lending instruments, such as a sector adjustment loan on a Bank Adaptable Program Loan (APL) synchronized with the GEF program were considered, but rejected as unsuitable for the proposed project, especially because of the project approval framework in China. The implementing agencies have expressed preference for a variable spread loan (VSL) during project preparation. The choice was confirmned with the Ministry of Finance (MOF), during negotiations. 4  2. Project Development Objective and Key Indicators The proposed project development objective is to demonstrate early success in large-scale, renewable energy development with participating local developers in one pilot autonomous region and one pilot province. Measures of outputs during project implementation include physical progress in procurement, construction, commissioning and operation of the proposed plant. Measures of project outcomes are the contribution of the project to creation of a market framework and an environment for development of renewable energy in Inner Mongolia Autonomous Region and Zhejiang Province. Project performance indicators are set out in Annex 3. 3. Project Components The project comprises two components: a 100 MW wind farm in Inner Mongolia Autonomous Region and a bundle of small hydro construction and rehabilitation projects in Zhejiang Province. Huitengxile Wind Farm, Inner Mongolia ($101.65 million, Bank financing $67 million) The proposed wind fann is at the Huitengxile site, about 120 km north east of Hohhot, and is currently home to approximately 70 MW of wind generation capacity. The site has a potential for about 1,000 MW and is well-established as one of the best sites in China for large-scale wind development. The Huitengxile wind farm will consist of wind turbines, associated electrical and civil works including a substation, switchyard and control room; a 15 kIn, 110 kV transmission line to Desheng town; and upgrading of the existing substation there. The power of the individual wind turbines will be in the range 0.75-1.5 MW, but their number and the precise layout of the wind farm will be determined at procurement and will depend on the product offered by the winning bidder. Based on feasibility study calculations using 67, 1.5 MW machines (considered to be the most likely configuration), permanent land acquisition including land for turbines, roads and substations, will total 23.65 hectares within an area of about 11 km2. The wind farm is expected to produce about 245 GWh of electricity per year. Power will be sold to the eastern Inner Mongolia grid, at 38.2 fen/kWh, a price based on competitive bidding for another wind farm at the same site. Inner Mongolia North Long Yuan Wind Power Company has also developed a proposal to sell carbon emissions reductions in the amount of 176,400 tons per year to the World Bank's Carbon Fund (CF). The CF Participants approved the project for inclusion in its portfolio in March 2005 and a Letter of Intenit was subsequently signed between the LMNLYWPC and the World Bank as the trustee of CF in June 2005. The additionality of the project (for carbon financing purposes) is based on: (a) the demonstrated requirement for additional revenues to improve the financial 5  viability of the project; and (b) the project sponsor faces technical barriers as the wind turbine technology it will adopt is not widely available in China. Due diligence on the project has been completed during pre-appraisal and appraisal of the wind farm and a follow-up mission in July 2005. Complementary work with Inner Mongolia North Long Yuan Wind Power Company (IMNLYWPC) and concerned government agencies led to the preparation of the Project Design Document (PDD) and the Emissions Reduction Purchase Agreement (ERPA). Signing of the ERPA is expected to take place in January 2006. Small Hydro Projects, Zhejiang ($30.76 million, Bankfinancing $19.33 million) In Zhejiang, the Bank will finance rehabilitation and development of selected small hydropower units. The component will provide subloans to individual companies carrying out rehabilitation or new construction of small hydro projects not exceeding 10 MW with guarantees from county governments. The projects are drawn from rehabilitation and new build projects requiring financing in Zhejiang Province. A framework under which Zhejiang would undertake its technical, economic, financial, safeguards and fiduciary due diligence on each of the subprojects has been prepared and agreed with the implementing agency. The subcomponent includes two parts: (a) rehabilitation of existing small hydro sites; and (b) development of new sites. Based on the appraised list of projects, the rehabilitation would consist of 11 projects with a total current capacity of 40 MW, which would be replaced by 52 MW. Total costs would be US$16.78 million for which Bank financing of US$10.99 million is sought. Seven new build projects would have an aggregate capacity of 16 MW with a total cost of US$13.99 million for which Bank financing of US$8.34 million is sought. Institutional Development and Capacity Building Institutional and capacity building in Inner Mongolia and Zhejiang is financed under the first phase of CRESP and is a single national program implemented through a national PMO under the Energy Bureau of NDRC. Support is programmed to assist in building a strong pipeline of bankable renewable energy projects. They will receive funds to carry out feasibility studies, resource assessments and other preinvestment activities on a cost-shared basis. Training and capacity building and access to international experience and best practice will also be eligible activities. More detailed project descriptions for the Huitengxile wind farm and the Zhejiang small hydro power components are in Annex 4. Project costs are set out in Annex 5. 4. Lessons Learned and Reflected in the Project Design Over the longer term, sustainability of development of the renewable energy sub-sector requires: (a) development of a competitive environment to reduce technology and project development costs; (b) flexibility to allow quick adaptation to changing market conditions, such as restructuring and deregulation of power sectors; and (c) minimal reliance on administrative procedures, and increased focus on market-based approaches as soon as barriers are removed. 6 - ~~~ ~ ~ ~ ~ ~~ ~ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~S - - - - - - -  These lessons have been incorporated into the design of CRESP, from which this project will benefit. At the project level, the following lessons have been learned from renewable energy assistance in China: * Consensus among all concerned agencies is vital to project success; * The renewable energy resource for individual projects must be carefully assessed and checked; * Attention muLst be paid to arrangements for procurement and construction that are in line with international best practice to ensure rapid and effective implementation; * Agreement on important principles that are essential to the project functioning as envisaged (for example, power offtake and purchase agreements) should be established before project appraisal; and * TA must be coordinated with the construction of the physical parts of the project to ensure that the implementing agencies have adequate and timely knowledge of construction, operation, and maintenance. Incorporation of these lessons learned in the proposed project required full engagement of all concemed Chinese agencies. 5. Alternatives Considered and Reasons for Rejection Scale up by TA alone was considered for Inner Mongolia and Zhejiang, to be fmanced under CRESP. However, during preparation, it became apparent that Bank-supported investnents would be required to jump start scale up and help the market for renewable energy to finction in Inner Mongolia and Zhejiang. Hence, the proposed investment operation became essential. Other investments in Inner Mongolia were investigated but rejected because of the priority the GoC attaches to wind and the importance of Inner Mongolia to the scaling up of the industry both in terms of individual wind farm size and replicability. In Zhejiang, other projects were also considered, including biomass and wind, but it was considered important to demonstrate the financial and commercial benefits of small hydro, especially the rehabilitation of old plants. A larger new build component was considered but rejected because of ithe need to demonstrate the potential and costs of rehabilitation, which offers considerable replicability and a significant low-cost renewable resource nationwide. C. IMPLEMENTATION 1. Institutional Development and Implementation Arrangements Huitengxile Wind Farm Component Inner Mongolia North Long Yuan Wind Power Company is the developer of the project and will own and operate the plant after commissioning. It is a credible developer, currently owned 50 7  percent by China Long Yuan Electric Power Group Corporation (Long Yuan), itself a well established wind developer, and a subsidiary of Guodian Corporation, one of the five state- owned generation companies that were formed on the break-up of the State Power Corporation of China. The other shareholder is Northern Union Power Group (NUPG), a holding company owning most of Inner Mongolia's power generation plants. A wind turbine supplier will be selected under international competitive bidding (ICB) to supply and supervise the installation of wind turbines, to design and supervise the manufacture of towers, to design and supervise the construction of foundations, and to provide design services for the balance of the wind farm, including electrical and civil works. Local contractors, not financed by the Bank, will manufacture the towers, and undertake electrical and civil works, under the supervision of the turbine supplier. International consultants have been hired to support the bidding process, including preparation of the bidding documents for the turbine supply, assistance during the bid period and in bid evaluation, and to assist in supervising the turbine supplier's work. Funds will be onlent from the MOF to the Inner Mongolia Autonomous Region, a-nd from there onlent to IMNLYWPC with a counter guarantee provided by NUPG. Zhejiang Small Hydro Component The Zhejiang sub-component consists of several small hydro projects. Rehabilitation projects are mainly within state or collectively owned county-level companies. New build projects are mostly sponsored by private companies. The list and main characteristics of the small hydropower projects are provided in Annex 4. A leading group has been formed by Zhejiang Province Government to oversee project implementation (also referred to as the Zhejiang Project Management Office). Capacity at the individual company level is limited, hence the component will be managed by a provincial project office (PPO) staffed by members of the Zhejiang Hydro Power Management Development Center (ZHPMDC) which has extensive experience in managing international cooperation projects and will oversee and provide additional capacity for the technical, financial, procurement and safeguard aspects of the individual projects. Individual subprojects will undergo due diligence by the provincial government, which has appointed ZHPMDC to act for it. A framework has been agreed and appraised by the Bank which sets out the technical (with special focus on dam safety), financial, economic, fiduciary and safeguards requirements a project must meet to be eligible for Bank financing. The framework is set out in the Project Implementation Plan (PIP). Due diligence of individual projects will be managed by ZHPMDC and expert consultants as required. The findings of the due diligence will be recorded and reported to the Zhejiang Project Management Office (represented by ZBPMDC) and the Bank. On completion of due diligence, each project owner will sign a subloan agreement with Zhejiang Province. All due diligence reports of the subprojects will be subject to prior review by the Bank. Retroactive financing of $1.9 million has been requested by Zhejiang and confirmed during negotiations. 8  Funds will flow frorn MOF to Zhejiang provincial finance bureau, on to county finance bureaus, and thence to project companies. Payments will be made on a reimbursement basis to project companies. 2. Monitoring and Evaluation of Outcomes and Results Data to permit monitoring progress towards the outcome indicators will be derived through surveys conducted at mid term and at the end of the project. These surveys will be financed by CRESP and conducted by the PMO; the capacity of the PMO will be strengthened as part of the Institutional Development and Capacity Building Component of the first phase of CRESP. Data on outputs will come from project progress and operations reports from the implementing agencies. The monitoring frameworks for the Huitengxile wind farm and the Zhejiang small hydro projects are set out in Annex 3. 3. Sustainability and Replicability The GoC's renewed commitment to the support and development of renewable energy is documented in the Letter of Sector Development Policy (LSDP), which is attached in Additional Annex 1A. The passage of the REL introducing an MMP is a major step toward sustainable scale-up of renewable energy. Success now hinges on adequate regulations and design of an effective regulatory system with GEF support to ensure adequate implementation. Sustainability is likely because (a) the rapid progress in developing and passing the law indicates the commitment of the government to meet the sector development objectives; and (b) CRESP's programmnatic approach provides a means of steadily broadening and deepening the engagement of all concerned parties, leading to the point where the legal and institutional framework of the country would be conducive to achievement of the ambitious objectives of the renewable energy development plan outlined by the GoC in its LSDP. Sustainability of the investment projects has been aided by reflecting in their institutional arrangements the principles set out in the law, namely creating a long-term requirement for renewable electricity at the provincial level, backed by power purchase agreements (PPAs) and ensuring cost recovery. The project supports this goal through various activities envisaged under the institutional development and capacity building provided under the first phase of CRESP to the project implementing agencies and more widely in Inner Mongolia and Zhejiang. 4. Critical Rislks and Possible Controversial Aspects Notwithstanding that the development of the renewable energy subsector is still in its early stages, the risk is considered to be modest. 9  Table 1: Risk M!itigation Measures Risk to Project Development Risk Mitigation Measure Risk Objective Rating Banks are not willing to lend to Awareness and capacity building for banks. M renewable energy projects on long Cofinancing with local banks in investment tenor and reasonable terms. proj ects. Weak or failing governmnent Individual projects not impacted by this risk M commnitment to because they have secured all government * Market-based approach and approvals, including off-take price. Financial competition. viability improved through sales of emissions * Legal basis for mandated market. reductions when needed. * Imnplementation of REL. * Enforcement of mandated market. Environmental externalities not Pricing issues dealt with through the REL and S incorporated into electricity pricing. related regulations mandate a price for electricity to be provided by renewable energy. State Council regulations mandate development of new pricing mechanisms that incorporate environmental externalities. Support provided to mitigate this risk under CRESP Risk to Component Results Poor quality or high cost of equipment TA program strongly supports quality M and services and of projects in improvement. Awareness-raising activities to operation. support quality improvement efforts. Standards and certification required in bidding documents as indicated above. Weak cooperation from agencies Pilot provinces selected on voluntary basis. N concerned with the govermnment and Incentives for participation, including substantial power sector in pilot provinces. TA to assist in implemnenting law and developing regulations. Pilot projects do not operate at close to Pilot projects sponsored by commercial, M international performance and price. reputable companies and prepared to international best practice, adapted to Chinese conditions. ICB for equipment supply. Overall Risk Rating M Risk ratings: H (high), S (substantial), M (modest), N (negligible or low risk). No controversial aspects have been identified. 1 0  5. Loan Conditions and Covenants There are no unusual loan conditions or covenants. Standard effectiveness conditions will apply: execution and delivery of the loan agreement must be duly authorized, and a legal opinion that the agreement is legally binding must be furnished. To avoid holding up the implementation of the other component, the signature of subsidiary loan agreements between the provincial finance bureaus and the implementing companies and other actions relating to each component have been made conditiors of disbursement. Implementation conditions include agreements that sales prices and quantities for electricity and connection arrangements will be provided for Huitengxile wind famn and each subproject in Zhejiang. Financial reporting aind auditing requirements will be followed. Furthermore, covenants have been agreed to ensure that the owners of the Inner Mongolia wind farm will pay in equity capital, by no later than the date of entry into service of the wind farm plant to the built under Part A of the Project. IMNLYWPC shall talke all actions as shall be necessary to ensure that the aggregate annual dividends to be distributed to its shareholders in any fiscal year, shall not exceed the said fiscal year's net eamnings of IMNLYWPC during the implementation of its Respective Part of the Project. D. APPRAISAL SUMMARY 1. Economic and Financial Analyses Economic It must be noted that the proposed components are part of the GEF/Bank supported China Renewable Energy Scale-up Program (CRESP), which was appraised and found economically justified during the preparation of CRESP-Phase 1. Cost benefit analyses were carried out to estimate the economic internal rates of return (ElRRs) of the two components. The economic costs of the components include total investment costs of the renewable power generation projects and connection, operations and maintenance (O&M) costs, and electricity losses incurred during transmission and distribution and station uses. The major benefits considered for the analyses are revenues from the sales of electricity as proxies of consumer willingness to pay (the most likely market for the electricity from Huitengxile is the North China Power Grid where consumer price averages 40 fen/kWh and in Zhejiang a 42.5 fen/kWh tariff is payable to small hydro producers, higher than the average sales price in the province); and benefits from lower pollution. Based on conservation assumptions for energy production and a relatively high discount rate (12 percent), the analysis showed that the EIRR of the Huitengxile wind farm would range from 11.1 to 12.8 percent depending on different but conservative value attributed to externalities. The range of EIRRs for the small hydro projects in Zhejiang is 10-33 percent. This confinns the economic viability of these projects even at this early stage of scale up. 11  Financial Two separate financial analyses were carried out: (a) at the project level, financial soundness of each component-the financial internal rate of return (FIRR) of the projects; and (b) for IMNLYWPC, at the entity level: its fmancial structure, efficiency, and viability. The financial analyses of the two investment components are based on the latest feasibility studies of the project components approved by the GoC and the project entities' audited historical financial accounts, as well as their latest financial projections. All the project components will be financed by IBRD loans, local loans and equity investments from the shareholders. The terms and conditions of the IBRD loans and local loans used in these analyses were those applicable in late 2004. For the Huitengxile wind farm, the FIRR was estimated at about 7.0 percent, which indicates that the project is marginally viable. The implementing agency was not ready to go ahead with the investment given the associated risks. However, with carbon finance, the FIRR would improve to about 9 percent, improving the financial viability and robustness of the project. The FIRRs for the 18 subprojects in Zhejiang range from 7-16 percent. The financial projections for JMNLYWPC indicate that the company will be able to service its debts once the wind farm is fully operational and during the first five years of operations (debt service coverage ratio ranging from 1.1 to 3.2), maintaining adequate liquidity (current ratio ranging from 1.9 to 6.6 times) and debt as a proportion of combined debt and equity does not exceed 72.3%. For fiuther discussion of the economic and financial analysis for the Huitengxile wind farm and Zhejiang small hydro projects, see Annex 9. 2. Technical Each investment subproject has been designed in accordance with international standards and best practice. For the Huitengxile wind farm, the design and layout used internationally recognized standards for wind resource assessment and energy calculation. Variable-speed pitch regulated machines meeting intemational standards will be specified for their superior performance and output power quality, which will help improve local system stability. Design specifications require wind turbines to meet local environmental conditions. In Zhejiang, projects will be required to meet Chinese technical standards for design, equipment specifications, construction and safety taking into account hydrology, geology and project size, layout and structure. Separate regulations are provided for new construction and rehabilitation. The Bank has reviewed these standards and has determined that they meet international best practice in most areas. Technical assistance (TA) is being provided through the Institutional Development and Capacity Building component of the first phase of CRESP to support those areas where practice falls short of international practice. 12  3. Fiduciary Financial Management In Inner Mongolia and Zhejiang, the financial management assessment concluded that the project companies met minimum Bank financial management requirements. An action plan has been agreed to ensure that adequate financial management capacity will be in place and developed in the project companies by project disbursement. Financial management for the Huitengxile wind farm and Zhejiang small hydro projects is fiuther discussed in Annex 7. Procurement IMNLYWPC has extensive experience with wind power projects, but not with Bank procurement. It was, however, considered to have adequate capacity to carry out procurement activities according to Bank Guidelines. IMNLYWPC is, in addition, now partly owned by Long Yuan, which is quite familiar with World Bank procurement procedures. The ZHPDMC has extensive experience of small hydro projects and will have a dedicated procurement team. All companies will use procurement agents familiar with Bank procedures. Procurement arrangements for the Huitengxile wind fanm and the Zhejiang small hydro projects are in Annex 8. 4. Social The adoption by the Chinese Government of a policy to promote greater use of renewable energy reflects a strong awareness of the impacts of coal use on health and the environment. The policy has been adopted following wide stakeholder consultation, including representatives of civil society. Both project components enjoy wide support among the communities which will host them, as they are seen as an important source of local income and employment during construction and operation. No major social issues have been identified. Monitoring of the social impacts will take place through (a) the resettlement action plans, discussed below; and (b) mid term and end of project surveys monitoring the scaling up of renewable energy markets. 5. Environment The project contributes to environmentally sustainable growth and protecting people's health from environmental protection. Reduction in local pollutants-SO2, NO,, and particulates will be monitored by reference to the substitution of renewables for coal-based electricity. The reduced CO2 emissions resultfing from the operation of the Huitengxile wind fann will be subject to an ERPA and will be monitored through that contract. 6. Safeguard Policies Safeguard screening category is S2, and the environmental screening category is B. 13  Table 2: Safeguard Policies -SafeguiLard Policies Triggered by the Project Yes No Environmental Assessment (OPJBP/GP 4.01) 1xI El Natural Habitats (OP)RP 4.04)U Pest Management (OP 4.09) ~ Cultural Property (OP 11.03, being revised as OP 4.1 1)UII Involuntary Resettlement (LP/RP 4.12) Indigenous Peoples (OD 4.2.0, being revised as OP 4. 1O0)*U I Forests (OP/hP 4.36) U1 tE Safety of Dams OP-/BP 4.37) tE U Projects in Disputed Areas (QP/Bji GP 7.60) Ul tE Projects on International Waterways (QP/BP/GPj 7.50) El tE *China uses the term "Ethnic Minorities" to describe those people covered by OD 4.20/OP 4.10. The Huitengxile wind farm component and the subprojects within the Zhejiang component will be carried out in compliance with Bank safeguard policies, and according to environment and resettlement plans that have been agreed with the Bank. For the investmnent project in Huitengxile, environment and resettlement plans have been agreed with the Bank and in Zhejiang, environment and resettlement frameworks have been agreed with the Bank and adopted by the province. Safeguards documents have been disclosed locally and in the World Bank Infoshop. No major safeguards issues have been identified. For further discussion on safeguards aspects of the Huitengxile wind farm and Zhejiang small hydro projects, see Annex 1 0. 7. Policy Exceptions and Readiness No policy exceptions for the project are required. Readiness conditions have been evaluated as follows: Table 3: Readiness Conditions Condition Inner Mongolia Zhejiang Fiduciary arrangements in place * Financial management * Yes * Yes * Procurement e Yes e Yes PMO/companies mobilized Yes Yes Counterpart funds/ local financing in place Yes Yes Bid documents for first year's procurement Yes Yes Final draft PIP available Yes Yes Disclosure requirements met (safeguards) Yes Yes Land acquisition pla-n ready' Yes Yes Domestic approvals secured Yes Yes 14  Annex 1: Country and Sector or Program Background Follow up Project to the First Phase of the China Renewable Energy Scale-up Program Heavy Reliance on Coal China's primary energy consumption more than doubled from 600 million tons of coal equivalent (Mtce) in 1980 to about 1,300 Mtce in 2000, whereas GDP quadrupled during the same period. Although based on slightly different growth assumptions, several studies carried out in the late 1990s and early 2000s by GoC and intemational agencies concluded that even in the case of increased and sustained energy efficiency efforts, energy consumption will continue to grow rapidly to between 1,850 and 2,150 Mtce in 2010 and to between 2,500 and 3,300 Mtce in 2020.2 They also concluded that even with an aggressive fuel diversification policy, coal will remain the dominant energy source. As did most of the studies, the one by the Chinese Energy Research Institute, found that coal's share in primary energy consumption, which accounted for 66 percent in 2000, would decrease only slightly, to about 65 percent by 2010, and slightly less than 60 percent in 2020 even if exceptional efforts were made in diversifying primary energy sources and improving overall energy efficiency (the "green scenario'). Under business as usual, coal's share in primary energy consumption would decrease to about 63 percent in 2020. Evidence from the early 2000s indicates that these and other studies have underestimated primary energy consumption growth. Primary energy consumption has soared from 1,300 Mtce in 2000 to around 1,700 Mtce in 2004, or 80 to 95 percent of the low and high studies' forecasts for consumption in 2010. About 50 percent of the coal consumed in 2004 was used for electricity generation. China's electric generating capacity is projected to increase from a little less than 400 GW now to between 950 and 1,100 GW by 2020. During this same period, coal-based electric generation capacity is expected to grow threefold to about 700 GW. This will require building about 500 to 650 GW of coal-based capacity (in the case of the more likely high growth, about 450 GW to meet the fast growing demand and about 200 GW to replace existing capacity). Coal-based generation will remain the predominant mode of electricity generation until 2030, accounting for more than 60 percent of total capacity and supplying around 70 percent of total electricity generation. The damage caused by SO2 and NO. emissions to agriculture and health is at the center of the debate on the 11 th Five-Year Plan and the long-term energy plan (China 2020). Estimates of the costs vary, according to existing studies, from 3 to 7 percent currently and could grow to as high as 13 percent of GDP in 2020, if environmental issues are not properly addressed. Emissions of carbon from coal combustion will also increase from about 820 million tons in 2000 to more than 2 The four studies used are (a) "Basic Concepts of the National Energy Strategy" 2004-unpublished draft by the Development Research Center based on a study by the Chinese Energy Research Institute presented during the "China Development Forum": China's National Energy Strategy and Reform," Beijing November 15-17, 2003; (b) World Energy Outlooks 2002 and 2004, International Energy Agency; and (c) International Energy Agency Outlook 2004-Energy Information Administration, Office of Integrated Analysis and Forecasting, U.S. Department of Energy. 15  1.1 billion tons in 2010 and more than 1.8 billion tons in 2020 even with sustained efforts in energy efficiency and fiuel diversification. Even then, China's CO2 emissions per capita would amount to only 20 and 30 percent of the OECD countries' in 2010 and 2020, respectively. China's highest level authorities recognize that a business as usual approach in the energy sector would lead to unacceptable environmental damages. They recently adopted a multipronged energy strategy aiming at: (a) improving the efficiency of the energy sector and bringing energy intensity in line with international best practice; (b) fuel switching through increased gas penetration and aggressive development of renewable energy use, especially for power generation; and (c) securing energy supply to meet the country's growing needs. Chinese authorities recognize the vital need to pursue vigorously each prong of the strategy and to rely more on market based approaches to achieve the higher level objectives of sustainable development and a "well off' society. Greenhouse Gas Emission by the Power Sector This awareness results from recognition of the negative effects of emissions from the coal combustion needed to fuel economic growth-the damages to human health from air pollution and the damages to agricultural crops and natural resources caused by acid rain. In addition to severe impacts on the national environment, China's growing consumption of fossil fuels is projected to make it, by 2015, the leading producer in the world of greenhouse gas (GHG) emissions. Most of the increase in carbon emissions to 1.8 billion tons in 2020 will come as a result of a rapid increase of fossil energy consumption.3 Electricity production is expected to generate a significant share of these emissions, as shown in Table Al.1 below. Table A1.1: Forecast Electricity Generation and Emissions in China, 2000 05 2000 2005 2010 2015 Electricity Generation (TWh) 1303 1676 2161 2855 Thermal Electricity Generation (TWh) 1071 1361 1743 2302 Estimated Emissions (million tons) Carbon 266 337 432 571 NO. 2.7 3.4 4.4 5.8 So, 7.0 8.8 11.3 15.0 TSP 0.4 0.6 0.7 1.0 Note: Based on forecasts from the State Power Corporation of China (2001). A Power Sector in Transition toward Competitive Markets Reforms in China's power sector during the 1980s and 1990s promoted a series of incremental changes that have resulted in a power sector largely unrecognizable from that in the early 1980s. In early 2002, government functions were largely separated from enterprise management. All energy enterprises were corporatized and operated as commercial businesses. Budget allocations have been phased out and subsidies practically eliminated. Investments are financed through equity and debt from a variety of public and private sources. Electricity prices were increased to reach, on average, long-term marginal costs of supply in most grids. 3 Asian Development Bank, "ALGAS: People's Republic of China," Manila, October, 1998. As noted above, such studies have consistently underestimated the actual energy consumption growth in China in recent years. 16  In April 2002, after approval by the highest authorities in China, the State Council released a comprehensive reform program in Document No. 5: > Outlining a long-term vision of expanding competition, starting with generation and focusing on regional markets during the 10O Five-Year Plan (FYP); > Initiating, in the areas where conditions permit, market trials that would allow generators to supply electricity directly to high-voltage or large customers during the 10t Five-Year Plan (2001-05). Price of the contracted electricity supply will be set through negotiation between the generation companies and the customers, with payments of the transmission and/or distribution service established according to the state regulated transmission and/or distribution tariffs; and > Establishing a State Power Regulatory Agency to ensure fair competition in the competitive segments of the industry and protection of consumers from monopoly abuses in the noncompetitive segments. This is a first step toward a modern light-handed regulation of the sector. The 2002 State Council Document No. 5 is a major step forward. It clearly states that the objectives of the reform in China are to continue the break up of the monopolistic structure of the industty and gradually expand competition to improve its efficiency and ultimately provide the customers with the best service at the lowest possible cost. The plan details these objectives in eight points: (a) break up of monopolies; (b) introduction of competition; (c) increase of efficiency; (d) improvement of pricing mechanisms with one important requirement being to link the price paid to generators to their emissions to foster the development of renewable energy and other clean generation; (e) optimization of resource allocation; (f) development of industry; (g) formation of a national grid; (h) establishment of competitive electricity markets. Despite the impressive progress achieved during the last two decades, China's power sector is still facing the following major issues: (a) heavy reliance on coal entailing large emissions of GHGs, particulates, SO2, and NO. with consequent environmental damages-potential climate change, adverse health impacts' deteriorating air quality and acid rain; (b) a piecemeal approach to restructuring of the power sector and slow development of a regulatory framework leading to inefficiencies and abuses of monopolistic or monopsonistic power, discrimination against independent and small power producers and disincentives to secure supply at least cost; (c) mismatch between loan maturities and economic lives of power projects; (d) inadequate wholesale electricity and transmission pricing systems; (e) low efficiency of electricity supply and use; and (f) lack of access to electricity for more than 30 million people in isolated rural areas. Commitment to Development of Renewable Energy China has long head one of the world's largest renewable energy programs, leading to the development of more than 30 GW of small hydropower and large-scale installation of improved woodstoves and biogas plants. The government's energy strategy in the 10th FYP emphasized renewable energy more strongly than in the past, as one measure to reduce the power sector's use 17  of coal in the medium to long term, and to provide modem energy services to remote rural households. For the first time, GHG emissions and climate change issues are dealt with in the Plan. The renewable energy policy in the 10th FYP identifies five objectives for which policies will be developed: > Increasing the share of electricity production coming from renewable energy; > Introducing greater competition in supply of renewable electricity to the grid and improved incentives to do so; > Supporting further commercialization and local manufacture of renewable energy equipment; > Encouraging better financing mechanisms, especially for private capital; and > Inproving cooperation between government departments. Analyses indicated that the greatest potential for displacing coal by renewable energy was in the power sector. The technical potential for renewable electricity in China includes about 160 GW of wind power; over 75 GW of commercially exploitable small hydropower; approximately 125 GW (300 Mtce) biomass energy; about 6.7 GW of known geothermal energy resources; and an abundance of solar insolation. With respect to renewable electricity, these resources make China one of the most well endowed countries in the world. Recognizing the potential, three high level Commissions in 1995 jointly prepared the New and Renewable Energy Development Program for 1995-2010. However, the targets for the year 2000 have not been realized and there still exist formidable barriers to meeting future targets, which are, reco gnized and set out in the LSDP contained in Annex lA. To address these barriers the government has passed an REL. The REL introduces a mandated market policy (MMP) which mandates that either a share of the electricity delivered to end consumers by power companies comes from renewable sources or imposes an obligation on power companies to buy renewable energy-based electricity at a government-determined price. Concomitant with that obligation are the rights of the power companies to recover the additional cost from consumers and for renewable electricity generators to be able to connect to the grid. Preparation of the implementing regulations, technical assistance for their implementation and further development of the legal and regulatory framework for renewable energy in China is supported under the CRESP. The government has indicated that the law and implementation regulations are guided by the following principles: > Adoption of best intemnational practice for renewable energy development, adapted for Chinese conditions; > Promotion of policies that are detailed, practical, and achievable. Targets should be clearly specified, roles and responsibilities of different parties clearly defined, investment requirements calculated, and sources of financing identified; > Integration of renewable electricity policies with power sector reform; 18  > Integration of renewable energy development plans with the strategic objective to develop Westem part of country, for example, with a focus on developing small hydro power, wind energy and solar energy; and > Transparency during development of policies to ensure support from all stakeholders during implementation. The NDRC should work more closely than before with other agencies and consult widely with national concerned agencies, provincial and local authorities, power companies, renewable energy industry, and banks. China Renewable Energy Scale-up Program4 CRESP Background CRESP was approved by the World Bank's Board on June 16, 2005. The program objective is to enable commercial renewable electricity suppliers to provide energy to the electricity market efficiently, cost-effectively, and on a large scale. The core of the program is GEF-financed support for institution and capacity building for the scale-up of renewable energy based electricity generation capacity. The first phase will contribute to the program's global objective through development and implementation of ihe legal and regulatory framework, based on the REL and its implementing regulations, to create and gradually increase the share of renewable energy-based electricity generation, and will support its effective implementation in four pilot provinces. The REL has been enacted and will be effective on January 1, 2006. Associated implementation regulations will be prepared and promulgated during this phase. Effective implementation and enforcement, which have always been problematic and uneven for environmental laws, will be piloted in three provinces, namely Fujian, Jiangsu, and Zhejiang and one autonomous region, Inner Mongolia, supported by well-targeted and sustained technical assistance. Technology transfer at the national level will be supported through capacity building and TA, focusing particularly on wind and biomass. Investments in important technologies will be undertaken in the four pilot provinces to demonstrate the viability of large-scale, renewable energy-based electricity generation. Expected duration is 3-4 years. GEF will provide a US$40.22 million grant to support the institutional development and capacity building component during the first phase, with cost-sharing from participants expected to contribute a further US$48.6 million for a total cost of about US$88.82 million.5 Triggers to move frDm GEF phase 1 to 2 will be based on indicators of institutional progress and scale-up of renewable energy development and will include (a) issuing of required regulations to implement the REL; (b) publication of resource assessments for at least two pilot provinces and technology improvement subgrants signed with at least five companies; (c) full commitment and 4 For a more extensive description of CRESP, the Project Appraisal Document (Report 30698, dated May 19, 2005) is recommended. 5 The cost-sharing is based only on the direct costs borne by the participants in the GEF-supported, cost-shared activities (which comprise around 33 percent of the proposed GEF budget), using a ratio of 1:3, which is based on experience gained during implementation of the Renewable Energy Development Project. Indirect and other. contributing programs' costs are more important, but difficult to quantify. 19  disbursement of at least half of the GEF grant for the first phase; and (d) approval by State Council of Bank-financed investments in all four pilot provinces. The GEF program is supported by an SIL, which finances investments in renewable energy in Fujian and Jiangsu provinces. The GEF program and the investments are combined into two components described below. CRESP Project Description Institutional DeveloRment and Capacity Buildin . The Institutional Development and Capacity Building component was designed to meet national priorities and the needs of the pilot provinces to initiate the scale-up of renewable energy, and will include the following: * MM? research and implementation support. Studies on further development of the MMP and its implementation, particularly on targets, tariff levels, policy development, sharing of incremental cost, trading and carbon trading, and long-term planning and preparation of implementing regulations. The main counterparts for these activities will be government bodies, and the main outcome will be legislation and regulations leading to sustained scaling-up of renewable energy; * Technology improvement for wind and biomass. This will cover technology development based on important local investments leveraged by small grants, cost-shared gra;nts or both, for wind and biomass. In addition for wind, it will cover preparation of standards, development of certification and establishment of a testing center. Beneficiaries will be Chinese wind and biomass equipment and related service suppliers, government bodies dealing with standards, and testing and accreditation agencies; and * Long-term capacity building. Support will be provided to selected universities to enter into twinning arrangements with leading international universities to develop postgraduate-level or specialist renewable energy engineering and other related courses and to offer fellowship programs to support senior specialists studying abroad. At the provincial level, TA will be provided for effective implementation of the REL and initiation of sustained scale-up or renewable energy: * Inplemexntation of the MMP by focusing on the tasks to make the REL effective in the pilot provinces, aimed principally at provincial government bodies and other stakeholders; * Support to ensure the success of the investment projects by providing assistance in design, procurement, construction, and operations and maintenance, as needed by each project sponsor; * Pilot or demonstration projects to be carried out in the pilot provinces supporting technologies other than wind, biomass, and small hydro with potential for replication in the pilot provinces component. In addition, a pilot offshore wind farm will be prepared for implementation in phase 2; * Renewable resource assessments for each of the pilot provinces; 20  * Capacity building for market participants; * Support for investment scale-up with the sponsors of the investment subprojects financed under the Support for Wind and Biomass in Pilot Provinces Component. The purpose is to build a strong pipeline of bankable renewable energy projects with strong sponsors; and * The Institutional Development and Capacity Building Component will include program management; and will cover the sustaining costs of the Project Management Office (PMO), GoC, and donor coordination activities, monitoring and evaluation, and administration, including fiduciary duties. Support for Wind and Biomass in Pilot Provinces. The two subcomponents, one each for Fujian Province and one for Jiangsu Province, are: * In Fujian, a 100 MW wind farm at Changjiang'ao, Pingtan Island. The Pingtan wind farm will consist of wind turbines, associated civil and electrical works, an extension to an existing control room, a switchyard, and a 15 km, 110 kV transmission line from the wind farm to the Beicuo substation, which will be upgraded to meet the evacuation needs. of the wind ifarm. Total cost of the subcomponent is expected to be US$103.92 million, of which US$67 million is to be financed by the Bank; and * In Jiangsu, a 25 MW straw-fired biomass power plant at Mabei Village, Rudong County. The Rudong power plant will consist of one 110 ton per hour, high-temperature, high- pressure. straw-fired boiler, one 25 MW steam turbine, and associated mechanical, electrical, and civil works. Total cost of the power plant is expected to be US$36.08 million, of wvhich US$20 million is to be financed by the Bank. At the time of CRESP's approval by the Board, GoC had made the commitment to a further two investment projects which are the subject of this document. CRESP Implementation Institutional Development and Capacity Building Component. The Institutional and Capacity Building component of CRESP is a single national program implemented through a national PMO under the Energy Bureau of NDRC. The CRESP PMO was first formed in May 2002 to undertake project preparation and will increase its capacity by adding and training new staff as the project enters into its implementation phase. The PMO will implement the CRESP institutional and capacity building components in Inner Mongolia and Zhejiang in parallel with the proposed investment projects and their respective implementing agencies. CRESP Economic Analysis During preparation of CRESP, extensive analyses were undertaken at the program level, to establish the economic, financial, and fiscal impacts of various MMP options using a simulation model. In the case of business as usual and no renewable energy scale-up program, the likely renewable energy-based electricity generation is expected to be 36 TWh in 2010 or 1.2 percent of total generation. A program focused on increasing power generation from renewable energy 21  sources, the costs of which are below the avoided financial cost of coal generation, would result in a renewable energy contribution of 79 TWh per year by 2010, excluding external costs and 89 TWh if they are included. Net annual benefits were estimated to be US$1.2 billion in 2010 and the NPV of the program estimated to be US$3.79 billion at a 12 percent discount rate. It must be noted that the government has announced a more ambitious target indicating higher assumptions on values of externalities, more optimistic assumptions for cost reduction or, possibly more importantly, a lower discount rate. Additional analyses were carried out to assess the sensitivity of the results to the different assumptions and in particular to the discount rate. A separate, additional, target of 11 TWh of wind (about 4 GW of capacity) was examined because wind does not make a contribution to the 89 TWh per year in 2010 under the assumptions considered in the study (especially the 12 percent discount rate). The analysis suggested that such a program would cost about US$410 million at a 12 percent discount rate and would be economically justified at a discount rate of about 5 percent. Incremental cost analyses were also carried out for the removal of barniers to investments that are assumed to become economically viable with consideration of environmental externalities during the lifetime of the program. With the program, and ignoring the external benefits, an incremental 115 TWh of electricity would be generated from renewable sources. This would result in an incremental reduction of carbon emissions of about 800 million tons during the 20-year lifetime of the installed capacity. For a GEF incremental cost of US$140 million, this implies that the cost per ton of carbon is around US$0.17. FinancialAnalysis In addition to the analysis of benefits to the economy, financial analyses were conducted to assess the incremental financial costs of the policies and their impact on the distribution of costs and benefits among different groups in society, including consumers, equity investors, renewable electricity producers, coal electricity producers, banks, and government. The main financial gains to the power sector are from reduced coal and financing costs. The main costs stem from increases in civil construction and taxes. Net discounted financial benefit of achieving the 89 TWh per year by 2010 is US$2.9 billion. Fiscal Impact Fiscal impact to local and provincial government is small, with a discounted gain of about US$100 million over the program from taxes being paid by the new power plant to provincial and local governments. 22  Annex IA: Letter of Sector Development Policy, NDRC Follow up Project to the First Phase of the China Renewable Energy Scale-up Program Ct4$ARZX VMWVQW$M November2, 2004 David Dollar Country Director China and Mongolia The World Bank Level 16, China World Tower 2 No. I Jluon enwai Avenue 100004 Beijing, P.R. China Dear Mr. Dollar, Re: Letter of Sector Development Policy on Renewable Energy Development in China China is a big country both in energy prduction and consumption. Along with the rapid development of China's economy and the living standard of the people, energy demand in China is increasing rapidly. Under the current energy structure, coal is the dominating resource; oil consumption depends partially on import. Environnental protection and cnergy security are becoming issues of particular conces Development and utlization of renewable energy is an important option to improve the environment, adjust the energy structure, increase the energy safety, achieve diversified energy supply and ensure sustainable development of the energy sector China is rich in renewable energy resources, of which the amount of hydro is about 400GW (50 MW and below capacity of small hydro is 120 GW),; wind resource exceeds 1,000 GW; biomass resource exceeds 600 million tons of standard coal, and solar energy resources are also abundant. China has the full capacity to provide clean, secure and sustainable energy supply for national economy and social development. Since 1992, the Government of China has signed the Rio Declmation, UN Convention on Climate Change etc. and has issued such documents as China Agenda for 21" Century, 10 Countermeasures for Environment and Development in China. These actions indicate the determination of the Chinese Governent in enforcing and implementing sustainable development stategy. The Govemment of China has set up a series of specific policy measures to promote the development and utilization of renewable energy and the development of the energy industry. The Chinese Government also conducted such programs as Rural Energy Comprehensive Building Program in One Hundred Counties; Development of Initial Rural Electrification Counties; the Program of Brightness and the Township Electrification Program; Riding the Wind Program and the pilot wind power concession projects etc.. Good achievements have been made in these programs. By the end of 2003, the total hydro power capacity in China reached 100GW (of which small 23  capacity reached 560 MW, and electric power generation fuelled by biomass reached 2,000 MW. More than 12 mnillion rural household biogas digesters and more then 2,000 large and medium-sized biogas digesters had been set up in China. Installation of solar water heaters reached more than 50 miillion square meters and the total capacity of PV systems was more tha 50 MW. During the International Conference for Renewable Energies Boon 2004, from 1 to 4 June, 2004, 1 have solemnly arnounced, on behalf of the Ch2inese Government, that China would start to develop the Renewable Energy Law to speed up the development and utilization of renewable energy. By'2020, the share of renewable energy (excludes larger thani 50MW hydro power) in the primary energy consumption wil occupy 10%1/. China is now drafting the Mid and Long Term Plan on Renewable. Energy Development and has incorpomated such a plan into the national economnic development plan. This will clarify the strategic objective of the renewable energy development; remove market bariiers and firm up the incentive measures for renewable energy development; it will also help to create the social and culturl environment for renewable energy development and promote the commercialization and scaled development of renewable energy. According to the Mid and Long Ternm Plan on Renewable Energy Development, the development target by the yea 2020 a're: the installed capacity of hydro power will reach 240 OW (75 GW of which will come from small hydro) and will replace an annual consumption of 250 million tons of standard coal equivalent, the installed capacity of wind power will reAch 20 OW and will replace an annual consmption of 15 million tons of standard coal equivalent; the installed capacity for biomass power will reach-20 OW and will replace an annual constumption of 28 million tons of standard coal equivalent, and the total finstalled capacity of PV systems will reachi 1,000 MW. Based on the target mentioned above, we are trying to speed up the pilot projects on wind power concession and biomass: power geneamtion. The davelopment speed of small hydropower and PV power is being inmplemented at a speed which is obviously faster than before. However, in general, the curren production cost of renewable energy in China is relatively high and is not competitive compared to the traditional energy. In order to accelerate the development of renewable energy, the Chinese Goverment hopes to obtain financial and technical support from international organizations such as the World Bank and GEE. The aimn is to increase local manufacturing ability for wind power generation and biomas generation; reduce generation cost of renewable energy; and create conditions for the development and utilization of reewable, energy. China will be keen to learn from international exrperiences and practices. The Chinese Government is willing to promote the commercialization and scale up of renewable energy development jointly with the international world: and contribute to the sustainable development of the economy. 'Me China Renewable Energ Scale-up Program (CRESP) is, for the timne being, the largest interntional technical assistance program. in China. We attach high importance to this program and hope to make joint efforts with GEF and the World Bank so as to push 24  and prmote the prcpartoy work, and makle the implementaton of the program as soon as possible. Wish you have a grat whiter. Sincerely yours, Zhang Guobao?' L4 4' Vice Minister ,I4 National Development and Refonn Conmnission 25  Annex 2: Major Related Projects Financed by the Bank and/or other Agencies Follow up Project to the First Phase of the China Renewable Energy Scale-up Program Table A2.1: Major Related Projects Latest Supervision Sector Issue Project (PSR) Ratings (Bank-financed projects only) Implementation Development Bank-financed Progress (IP) Objective (DO) Reliance on coal, renewable energy First Phase of the China S S development, law and regulation Renewable Energy Scale-up based competitive markets for Program renewable energy Coal dominance, renewable energy Renewable Energy S S deve nt Development Goal dominance, access, financing Hubei Hydroelectric S S Coal dominance, environment Shanghai Waigaogiao S S Energy efficiency Energ Conservation S S Energy efficiency Energy Conservation II S S Sector restructuring, market reforn Tongbai Pumped Storage S S Sector restructuring, market reform Yixing Pumped Storage S S Other development agencies Low efficiency ADB (TA No. 2789-PRC) n/a n/a Strengthening Demand Side Management in Guangdong and Zhejiang Province Coal dominance, renewable energy UNDP/GEF China: Capacity n/a n/a development Building for the Rapid Commercialization of ____________ _ Renewable Energy Coal dominance, access ADB/GEF: China Agricultural n/a n/a Waste Utilization Project Coal dominance, renewable energy UNEP/GEF: Solar and Wind n/a n/a development Resource Assessment (Global including China) Coal dominance, renewable energy UNDP/GEF: Promoting n/a n/a development Methane Recovery and Utilization from Mixed Municipal Waste Coal dominance, renewable energy GTZ: Research and training n/a n/a development centre for wind energy Coal dominance, access GTZ: Renewable energies in n/a n/a rural areas IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) 26  Lessons Learned from Previous Projects The OED Report The Bank's Assistance to the Energy Sector in China (Report 21891, February 28, 2001) noted that "With none of the 20 completed projects rated unsatisfactory and only one of the 19 ongoing projects rated a problem project, the performance of the China energy portfolio is without equal." Today in the power sector in China, there are 18 completed projects, all rated satisfactory, 9 ongoing, again all rated satisfactory. No ongoing energy sector project is rated less than satisfactory. Nonetheless, important lessons can be drawn from previous energy sector projects, including: (a) the need for full commitment of the Borrower at all levels; (b) the importance of stakeholder participation throughout; (c) important policy reforms, in line with government objectives, should be incorporated into the project design; (d) project preparation should include detailed organizational and staffing arrangements for implementation and implementing agencies should receive institutional strengthening support; (e) counterpart funding should be committed before implementation, with the direct participation of relevant levels in NDRC, MOF, and other agencies; (f) projects crossing institutional lines are more difficult to implement and must provide adequate incentives to all participants; (g) capacity building during project preparation can achieve part of project objectives and substantially speed up implementation; and (h) power markets should be carefully assessed and periodically reassessed to ensure a demand for output from proposed projects. Lessons leamred from renewable energy assistance in China include: (a) the renewable energy resource for individual projects must be carefully assessed and checked; (b) for rapid implementation, attention must be paid to ensuring arrangements are in place for procurement and construction thiat are in line with international best practice; (c) important principles of all agreements that are essential to the project functioning as envisaged (for example, PPAs and voluntary pilot schemes) should be: established before project appraisal; and (d) TA must be coordinated with the construction of the physical parts of the project to ensure that the implementing agencies have adequate and timely knowledge of construction, operation and maintenance. 27  Annex 3: Results Framework and Monitoring Follow up Project to the First Phase of the China Renewable Energy Scale-up Program Table A3.1: Results Framework fOu Doe ;Ind;. icators-. ;Useof Outcome Infdriationdon To demonstrate early success in Evidence that the market Verify progress toward large-scale renewable energy framework in pilot provinces has achievement of PDO investments with participating been established through laws and local developers in one pilot regulations (through technical and Gauge project contribution to province and one pilot social surveys) objectives of CRESP autonomous region Evidence that in the pilot provinces At midterm review, gauge the environment for development of progress and effectiveness of renewables has improved (through project technical and social surveys) At midterm and completion, Evidence of improved quality and gauge effectiveness of law, reduced cost among manufacturers regulations and service providers in wind (through technical and social surveys) Increased renewable electricity over baseline (TWh/year), increased renewable capacity over baseline (GW), increased size of individual projects Reduced emissions (million tonmes): Carbon NO,, so, Particulates interniediate Results . kesulltsIndicators for Each ...:-,. Use:of Results Moitoiug One per:Component ;-. Component . : _-_...._;_'l___ Component One: Component One: Component One: Capacity to develop, finance, Wind farm at Huitengxile, Iner Monitor progress of construct and operate wind farms Mongolia component expanded Component Two: Component Two: Component Two: Capacity to develop, finance, Small hydro capacity rehabilitated Monitor progress of rehabilitate/construct and operate and newly built in Zhejiang component small hydro plant expanded _ _._l_l_l 28  Table A3.2: Arrangements for Results Monitoring - Program Responsibility Outcome Indicators (Phase I) Baseline Mldterm Phase end Frequency and Reports Data Collection Instruments for Data {._____________________ C ollection Market framework in pilot provinces None Some evidence Substantial Six monthly progress Discussions with provincial authorities, CRESP PMO established through laws and regulations. evidence reports, midterm and end reports from consultants responsible for of project reviews providing support in implementation, technical and social surveys Environment for development of None Some evidence Substantial Six monthly progress Discussions with companies, monitoring of CRESP PMO renewables improved evidence reports, midterm and end progress on cost reduction/quality of project reviews improvement activities, technical and social surveys Improved quality and reduced cost None Some evidence Substantial Six monthly progress Discussions with equipment and service CRESP PMO among manufacturers and service evidence reports, midterm and end providers and users, monitorirng of providers in wind of project reviews progress on cost reduction/quality improvement activities, technical and social survey Delivered renewable electricity in 2010 35 45 60 Midterm and end of CRESP PMO t (TWhIyr) and installed renewable 7.0 8.9 11.9 project reviews Baseline established by analysis based on O capacity in 2010 (GW) reference year of 2005. Subsequent years, analysis of new build renewable plant from reports from provinces Annual reduced carbon emissions, 15 18 (Carbon) 23 (Carbon) Midterm and end of (million tonnes); NO,, SO, and TSP (Carbon) 136 (NO.) 171 (NO,) project reviews Baseline established by analysis based on (thousand tonnes) 111 (NO,) 675 (SO,) 852 (SO,) reference year of 2005. Subsequent years, 554 (SOQ) 18 (SP) 23 (TSP) analysis of new build renewable plant from 15 (TSP) J reports from provinces Results Indicators for Each Component . Additional Potential Investments under Component Two: 100 MW wind arm at Huitengxile, 0 0 100 MW Six monthly progress Company progress reports IMNLYWPC Desheng County, Inner Mongolia selling 245 GWh reports for supervision 245 GWh/year into local grid by 2008 28 MW of capacity of small hydro in 0 0 28 MW Participant cornpany Managing agency reports for supervision ZHPMDC Zhejiang built or rehabilitated, seling an 95 GWh reports, aggregated into incremental 95 GWh/year into local grid six monthly progress reports for supervision  Annex 4: Detailed Project Description Follow up Project to the First Phase of the China Renewable Energy Scale-up Program The project has two components as described below. Huitengxile Wind Farm, Inner Mongolia Estimated cost US$101.65 million, of which US$67.00 million would be financed by the Bank. The Huitengxile wind farm is being developed by IMNLYWPC, which is a state-owned enterprise, 50 percent owned by Northern Union Power Group (NUPG), a holding company owning a number of power generation companies in Inner Mongolia, especially in Western Inner Mongolia. The other 50 percent is owned by Long Yuan, the same entity developing the Pingtan wind farm financed under CRESP Phase 1. Inner Mongolia Wind Power Company was the original sponsor whose operations have now been subsumed into IMNLYWPC. It was selected by the government of Inner Mongolia Autonomous Region to develop the wind farm; supply price is based on competitive bidding for another wind farm at the same site and has been agreed at 38.2 fen/kWh. Huitengxile is about 120 km east northeast of Hohhot, the capital of hIer Mongolia Autonomous Region. Its latitude and longitude are 41