China - Lubuge Hydroelectric Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-3710-CHA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPM TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO $145.4 MILLION TO THE PEOPLE'S REPUBLIC OF CHINA FOR THE LUBUGE HYDROELECTRIC PROJECT January 23, 1984 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 (December 1983) Currency Unit Yuan (Y) $1.00 Y2.00 WEIGHTS AND MEASURES kW = Kilowatt MW = Megawatt (1,000 kW) kWh = Kilowatt hour (860.42 kcals) GWh = Gigawatt hour (million kWh) kV = Kilovolt km = Kilometer ABBREVIATIONS AND ACRONYMS ADAB - Australian Development Assistance Bureau AGN - Advisory Group of Norway FCB - Fourteenth Construction Bureau KHIDI - Kunming Hydroelectric Investigation and Design Institute LPCMB - Lubuge Project Construction Management Bureau MOF - Ministry of Finance MWREP - Ministry of Water Resources and Electric Power PCBC - People's Construction Bank of China SBC - Special Board of Consultants SMEC - Snowy Mountains Engineering Corporation SPC - State Planning Commission YPEPB - Yunnan Provincial Electric Power Bureau GOVERNMENT OF THE PEOPLE'S REPUBLIC OF CHINA FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY CHINA LUBUGE HYDROELECTRIC PROJECT Loan and Project Summary Borrower: The People's Republic of China Beneficiary: Yunnan Provincial Electric Power Bureau (YPEPB) Amount: $145.4 million, including capitalized front-end fee Terms: 20 years, including 5 years of grace, at standard variable interest rate Relending Terms: The proceeds of the loan will be onlent from the Government to YPEPB, with a 20 year term, including 5 years of grace, at 8% p.a. interest. Project Description: The project will provide additional generating capacity and energy to Yunnan power grid; introduce modern tech- nology in construction of dams, tunnels and underground powerhouses; provide technical assistance in international competitive bidding (ICB) for civil works; address finan- cial and auditing issues; introduce financial forecasting; promote cofinancing; and provide staff training. The project comprises construction of a rockfill dam, spillway system, intake structure, headrace tunnel, surge shaft, underground powerhouse, and tailrace tunnel; installation of three 150 MW generating units and provisions for a fourth unit; construction of 220 kV transmission lines with associated substations; consultant services; and a training program. Risks are normal for a major hydroelectric project of this type. A Special Board of Consultants (SBC) has been appointed to give advice on design and technical problems during construction. Cofinancing (grant aid) has been secured from Norway ($11.6 million), Australia ($7.1 million), Canada ($0.2 million), and UNDP ($0.03 million). Export credits of about $41 million are also expected to be utilized. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - Local Foreign Total Estimated Costs: ---- ($ million) --- Main civil works 239.7 79.9 319.6 Hydraulic equipment 8.1 1.2 9.3 Electrical & mechanical equipment 43.7 46.4 90.1 Transmission lines and substations 35.3 17.6 52.9 Land acquisition, compensation & resettlement 8.6 - 8.6 Consultant services 17.1 10.1 27.2 Training 2.0 3.0 5.0 Base Cost (mid-1983 prices) 354.5 158.2 512.7 Physical contingencies 24.2 11.6 35.8 Price contingencies 31.3 35.2 66.5 Total Project Cost /a 410.0 205.0 615.0 Interest during construction 51.4 44.8 96.2 Front-end fee on Bank loan - 0.4 0.4 Charge on use of foreign capital 100.1 - 100.1 Total Financing Required 561.5 250.2 811.7 Local Foreign Total Financing Plan: ----($ million) --- IBRD loan - 145.4 145.4 Norwegian Government grant - 11.6 11.6 Australian Government grant - 7.1 7.1 Canadian Government grant - 0.2 0.2 Export/suppliers' credits - 40.9 40.9 Local bank loans 561.5 45.0 606.5 Total 561.5 250.2 811.7 Estimated Bank FY 1984 1985 1986 1987 1988 1989 1990 Disbursements: ----------------- ($ million) ---------------- Annual 14.5 21.8 29.0 29.0 29.0 14.6 7.5 Cumulative 14.5 36.3 65.3 94.3 123.3 137.9 145.4 Economic Rate of Return: 12% Staff Appraisal Report: No. 4334-CHA, dated January 23, 1984. /a Includes identifiable taxes and duties totalling about $44 million.  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE PEOPLE'S REPUBLIC OF CHINA FOR THE LUBUGE HYDROELECTRIC PROJECT 1. I submit the following report and recommendation on a proposed loan to the People's Republic of China to help finance the Lubuge Hydroelectric Project. The loan, for $145.4 million, would have a term of 20 years, including five years of grace, at standard variable interest rate. The proceeds of the loan would be onlent to the Yunnan Provincial Electric Power Bureau (YPEPB) with a 20 year term, including 5 years of grace, at 8% p.a. interest. YPEPB would bear the foreign exchange risk. Cofinancing has been secured, or agreed in principle, from several sources: a $26,000 grant already obtained from UNDP; a $1.3 million grant already secured from the Australian Development Assistance Bureau (ADAB) and a further Australian grant of $5.8 million agreed in principle; and grants committed by the Norwegian Government ($11.6 million) and the Canadian Government ($0.2 mil- lion). Export credits of about $41 million are also expected to become available. PART I - THE ECONOMY 2. An introductory economic report, entitled "China: Socialist Economic Development" (No. 3391-CHA), was distributed to the Executive Directors on June 1, 1981. A country economic memorandum, entitled "China: Recent Economic Trends and Policy Developments" (No. 4072-CHA), was distri- buted to the Executive Directors on March 31, 1983. Another economic mission is now in the field. Basic data on the economy are given in Annex 1. Background 3. Following a period of major institutional changes in the 1950s, including land reform and the eventual establishment of communes in rural areas and the extension of public ownership to cover almost all of the modern sector, development efforts in China have been directed toward the major objectives of industrialization and poverty reduction. Despite sharp oscillations in policy and political upheavals like the Great Leap Forward (1958-61) and the Cultural Revolution (1966-76), China has made substantial progress toward achieving its objectives. Industrial growth since 1949 has averaged more than 12% p.a. (compared with under 5% for agriculture); the current share of industry in GDP (around 44%) is similar to the average for middle-income developing countries; and the country now produces a far greater variety of industrial goods than most other developing countries. Per capita GNP (with adjustments for international comparability) grew at 2.5-3.0% p.a. in 1957-81, significantly above the average for other low- income developing countries. In terms of basic education, nutrition and health the Chinese population is better off than its counterparts in other low-income developing countries.  - 2 - 4. However, China remains a very poor country, with a GNP per capita of only $300 in 1982 and about 200 million people or 20% of the population with unacceptably low incomes. The economy is also inefficient: past growth has come mainly from massive mobilization of resources. For a country that faces significant domestic resource constraints, inefficiency is a particularly serious problem. 5. To address these problems and ensure rapid growth and improvements in living standards, the Government initiated a program of reform and adjust- ment in 1979. Economic reform, aimed at improving the efficiency of the economic system, involves: (a) improving the quality of central planning and policy coordination; (b) devolving more decision-making authority to lower level units; (c) establishing more direct links between incomes and the performance of economic units and individuals; and (d) relying more on market mechanisms and economic instruments and less on administrative directives to influence economic activity. Structural adjustment, aimed at speeding improvements in living standards, has involved readjusting the relative shares of consumption and investment in national income, some major sectoral and subsectoral readjustments, and greater emphasis on foreign trade. In 1981, problems with inflation and large budgetary and current account defi- cits resulted in short-term stabilization temporarily receiving the highest priority, but by 1982 the Government was again pushing ahead rapidly with adjustment and reform. Economic Reform 6. Reforms have now affected all sectors of the economy and institu- tions from the central government down to rural households. A major govern- ment reorganization has strengthened the core planning and management agencies (especially the State Planning Commission and the State Economic Commission) and reduced the number of commissions, ministries and agencies under the State Council from 98 to 52. Reorganization within ministries also has occurred, while that of provincial and local governments is now under way. Economic management has been decentralized: provincial and local authorities have been given more autonomy in investment decision making and use of credit to finance investment has increased; provincial and local governments have been granted greater budgetary flexibility and more incentives to expand revenues and/or economize on expenditures; and ministries, new local trading companies and some enterprises now have authority to engage directly in foreign trade. 7. Reforms have been most far-reaching in rural areas, where introduc- tion of various types of the "production responsibility system" has given small groups and households more autonomy in production and investment decisions and linked incomes directly with output. By the end of 1982, 92% of production teams in China had implemented such a system; 78% had imple- mented a household responsibility system, whereby collective ownership of farm land and major equipment is maintained but plots of land are contracted out to individual households, which can retain whatever they produce beyond their obligations to the state and to the collective (which account for about one third of production). The number and types of rural markets have also increased.  -3- 8. Economic reform has not proceeded as far or as fast in urban areas, but significant systemic changes have occurred. Reforms in the management of state enterprises have aimed at improving incentives through profit retention schemes and more flexible payment and employment practices. There have also been experimental changes in the organization of state enterprises, a greater variety of marketing channels, some price flexibility and adjust- ment of relative prices, and greater autonomy for state enterprises in pro- duction decisions. The scope for cooperative and individual economic activities has also been enlarged. 9. Many economic reforms, especially those in rural areas, have already had a positive impact on efficiency, while others will take longer to have a significant effect. There are also some emerging issues with economic reform that the Government will need to address. In rural areas, there is a potential conflict between enhanced economic incentives and equity in income distribution, continued provision of basic services, and mobiliza- tion of labor. In the state enterprise sector, many units are still inclined to overinvest and overproduce, since substantial decentralization of decision making and control over resources has not been accompanied by necessary reforms in the pricing system. More use is being made of the market, but information and transport systems are still weak, markets are fragmented and competition is limited. It has also been difficult to develop effective indirect fiscal and monetary policy instruments. Adjustment, Stabilization and Growth 10. During the past four years, the Government has followed a strategy of setting relatively modest targets while implementing economic and admin- istrative measures that contribute to adjustment and stabilization as well as to economic growth. The various measures have included: major increases in agricultural procurement prices; strict controls on many other prices; rationing and other administrative measures to improve efficiency of resource use; cutbacks in state capital construction investment; fiscal measures to limit the budget deficit; increases in interest rates; moderation of currency and credit expansion; and the introduction of an internal settlement rate for foreign exchange transactions and other measures to encourage exports and economize on imports. 11. These economic and administrative measures, combined with systemic changes, have played an important role in the impressive performance of the Chinese economy in recent years. Gross agricultural and industrial output at constant prices grew by 7.3% per year between 1978 and 1982 - agriculture by 7.5% and industry by 7.2% (heavy industry by 3.4% and light industry by 11.8%). Net material product (NMP) at constant prices grew by an estimated 6.3% p.a. during the same period. Net investment has stagnated in real terms, while material consumption grew by over 9% p.a. between 1978 and 1982. The share of investment in NMP was reduced from 36% in 1978 to 29% in 1982. Domestic consumption of energy rose by less than 2% p.a. during 1978-82.  - 4 - 12. Structural adjustment and rapid overall economic growth, combined with a low population growth rate (1.3% p.a. between 1978 and 1982), have led to rapid increases in per capita incomes. In urban areas, real per capita incomes increased by 4.8% p.a. between 1978 and 1982; in rural areas the real increase in per capita incomes was about 12% p.a. While more prosperous areas and households may have benefitted the most and income differentials at a local level may have increased, many poor areas and households have also enjoyed substantial income improvements. 13. The high rate of investment in 1978 and the low returns to much of this investment made a cutback in the investment rate a priority for the adjustment program. But achieving such a cutback has proved difficult. Decentralization of investment decision making has permitted a rapid growth in investment financed from retained earnings or local resources. As a result, most of the cutbacks in investment have been in large centrally financed projects (in 1981 even the priority sectors of energy and trans- portation were affected), though some of these were revived in 1982. 14. Government policy measures have helped restore domestic economic stability by lowering the rate of inflation from 6% in 1980 to 2.4% in 1981 and 2% in 1982, and by reducing the budget deficit (adjusted to eliminate financing items) from 7% of NMP in 1979 and 5% in 1980 to less than 2% in 1981 and 1982. The restoration of fiscal stability was achieved mainly by sharp cuts in expenditures on investment. Subsidies (mainly on daily living necessities) rose dramatically from about 7% of total expenditures in 1978 to 26% in 1982, when they were 9% of NMP. 15. China's external position has also changed greatly in recent years; the current account deficit of $3.4 billion in 1980 was converted into a $5.6 billion surplus in 1982 and an estimated $4.6 billion surplus in 1983, an improvement far greater than anticipated. The real growth of merchandise exports has been very impressive, averaging over 15% p.a. during 1978-82, mainly because of rapid growth in manufactured exports. The growth rate has been declining steadily, however. Meanwhile the volume of imports declined in both 1981 and 1982, due in part to the lagged effect of contract cancel- lations and suspensions, but also to delays in equipment deliveries and to problems in obtaining high technology goods. A substantial increase in imports is expected in 1984 and 1985 as China expands its investment program and imports more machinery and equipment. 16. A major consequence of the Government's conservative balance of payments strategy has been reduced foreign borrowing. In 1980 and 1981 the Government cut back sharply on interbank borrowing and in 1982 took advantage of the unexpectedly strong current account position to repay commercial bank and other loans. In 1981 China's debt service ratio was 7.8%, and in 1982 10.0%, due in part to accelerated loan repayments. At the end of 1981 total reserves (excluding gold) were $5 billion; by the end of 1982 they had increased to over $11 billion (equivalent to about seven months of 1982 imports).  -5- Medium-Term Prospects 17. During the remainder of the 1980s, the Government's efforts to improve living standards should be helped considerably by continuation of a relatively low population growth rate; by opportunities to make greater and more efficient use of foreign technology and capital; and by the potential for improving efficiency through economic reform. Rapid and equitable econ- omic development is constrained by a number of factors, however. There are serious shortages of skilled manpower (current enrollment in universities and technical and vocational schools is one quarter of the average rate for other developing countries). With limited possibilities for expanding the cultivated area and with cropping intensities and yields already quite high, the growth rate for agriculture is unlikely to average more than 3-4% p.a. during the 1980s. Energy availability will continue to constrain industrial growth, and there are capacity constraints in the transport and commercial sectors. Large investments will be required in energy and transport at a time when competing demands from other sectors, especially housing, are very great, domestic revenues have not been growing rapidly, and decentralization has weakened government control over investment. 18. In recognition of these difficulties, the Government's Sixth Five- Year Plan (published in December 1982 but covering the period January 1981 December 1985) emphasizes continuation of the program of "adjustment, reform, consolidation and improvement of the national economy." The plan period is essentially viewed as an interim period during which the foundation will be laid for more rapid economic development under subsequent plans. Modest targets are set for production and income growth (4% p.a. for gross agri- cultural and industrial output and for NMP), consumption is expected to grow faster than investment, prices will be kept basically stable, the budget deficit will be kept low, and a significant expansion in foreign trade is forecast, with imports growing more rapidly than exports. Priority will be given to measures improving efficiency rather than maximization of output, but the Government expects most production targets to be surpassed, as they have been in the first two years of the Plan. 19. Reform implementation will continue during the next three years. Rural reforms will be broadened and strengthened, with the production responsibility system extended to new spheres of activity, new types of organization (including joint ventures between rural and urban units) encouraged, and the administrative functions of communes separated from their economic functions. In state-owned industry, taxation will replace profit remittance as the primary means of raising government revenue, indus- trial administration will be streamlined, and more inefficient enterprises will be closed down. The commercial system will be reformed and cooperative and individual commerce, particularly in rural areas, will be promoted. In investment planning, the Government is striving for more effective imple- mentation of existing administrative regulations, but improving the structure and efficiency of investment will be a long and difficult process, dependent very much on progress on other aspects of reform. Measures to introduce formal economic analysis (including use of shadow prices) into investment  -6- decisions and to make producing units more economically and financially responsible for their decisions through appropriate pricing and incentive schemes are especially important. Price reform itself is recognized as being crucial, but in view of the complexities and magnitude of the changes required, the Government has decided that it cannot implement comprehensive price reform until after 1985. However, appropriate upward or downward adjustments in the most distorted prices are being made, and the prices of many minor commodities are being allowed to fluctuate according to market conditions. 20. During the remainder of the 1980s, China's development and moderni- zation programs are expected to result in rapid growth of imports of capital and intermediate goods. Foreign capital requirements for energy development will be particularly heavy. By the late 1980s, some imports of oil are also likely to be necessary before new domestic energy production capacity is established. China's temporary current account surpluses thus are expected to change to moderate deficits over the next several years. But the overall rate of import expansion, the size of the current account deficit, and the magnitude of foreign borrowing requirements are very sensitive to assumptions about economic trends and the effectiveness of government programs. For example, an acceleration of economic growth without significant improvements in efficiency, especially energy efficiency, could result in large current account deficits by the end of the 1980s. In fact, a relatively high rate of economic growth of 6-7% p.a. during the rest of the 1980s (which is the growth rate used in the projections in Annex 1) will probably be feasible only if major improvements in energy efficiency continue. 21. China has a strong claim to concessionary lending because it is still one of the poorer countries in the world. However, access to concessionary capital to finance its development and modernization program is limited: apart from Bank Group funds, a significant amount of concessionary capital is likely to come only from Japan and a few other bilateral donors and will probably average only $500-600 million a year during the 1980s. 22. For China, as for many other developing countries, the 1980s will be a difficult decade. But looking further ahead, China's economic prospects appear favorable. By 1990, most new entrants into the labor force will have received some secondary education, and the skilled manpower deficit will have been reduced. Further progress will have been made in tapping China's large energy potential and in using it more efficiently. Continuation of recent manufactured export trends should generate additional foreign exchange, enabling the Government to use foreign capital more freely and be less con- cerned about its terms. If the country's immense wealth of human talent, effort and discipline can be combined with policies that increase the effi- ciency of resource use, China will be able to achieve continuing substantial increases in the living standards of its people. Whether this potential can be realized, however, will depend crucially on the success of the Government's program of reform and adjustment in the 1980s.  - 7 - PART II - BANK GROUP OPERATIONS IN CHINA 23. In view of the particular circumstances of China and the economic transition now under way, the Bank's relationship with China should have several broad objectives. Firstly, the Bank should offer China its devel- opment experience and institutional knowledge gained in other countries and help China to re-establish its position in the world community after its lengthy isolation. Secondly, the Bank should assist China in removing the major constraints on development: shortages of energy, transport infra- structure, skilled manpower and modern technology. Even more important, the Bank should help the authorities to use these and other inputs more efficiently, by improving project analysis and investment control, as well as overall economic management and planning. Finally, the Bank should help the Government identify ways of reducing China's remaining poverty. Since the Government has been successful in meeting the basic needs of most of its people, these efforts should concentrate on the poorest rural areas. 24. Since China's change of representation in the Bank Group in May 1980, 11 projects involving lending of about $1,068 million have been approved. Three have been in education (University Development, Agricul- tural Education and Research and Polytechnic/TV University), two in energy (Daqing Oilfield Gaotaizi Reservoir Development and Zhongyuan-Wenliu Petroleum), three in agriculture (North China Plain, Heilongjiang Land Reclamation and Rubber Development), one in transport (Three Ports), one in industry (Industrial Credit), and one in technical cooperation (Technical Cooperation Credit). Annex II contains a summary statement on these loans and credits as of September 30, 1983. Economic and Sector Work 25. The Bank's economic and sector work was initially designed to pro- vide a basis of knowledge on the development and functioning of the Chinese economy. This work resulted in completion of a nine-volume introductory economic report in June 1981. A follow-up country economic memorandum (Report No. 4072-CHA) analyzing developments over the next two years was distributed to the Executive Directors on March 31, 1983. In addition, the Bank has undertaken studies in several areas important for our understanding of the Chinese system, including rural finance and urban planning and manage- ment in Shanghai. 26. Other economic work is designed to assist China in its present effort to promote efficient use of investment resources, and more generally to introduce new methods of economic management and planning. As prepara- tion for the Industrial Credit Project, an appraisal manual has been developed with Bank assistance by the new financial intermediary, the China Investment Bank. The Bank is now helping to develop a similar manual for the Agricultural Bank of China. A program of economic research on China's  - 8 - development problems, aimed at the application of advanced analytical tech- niques, is underway in collaboration with Chinese economic research insti- tutions in the areas of enterprise incentives and analysis of structural change. 27. Sector studies will help inter alia to identify and prepare future investments. Some have been included in Bank Group-financed projects, e.g., agricultural development in Shandong Province under the North China Plain Project, containerization under the Three Ports Project, and agricultural manpower and research under the Agricultural Education and Research Project. A health sector review looked at rural health care delivery systems and health manpower development. Near-Term Lending 28. Work has begun on a range of projects, with emphasis on improved management and efficiency as well as on technical assistance and training. Several are in the key sectors of energy and transportation. In energy, the Bank's efforts will help to increase the supply of fuel and power. Future petroleum projects will, like the first two, emphasize the introduction of modern technology, staff training and studies. Other operations are likely to continue support for electric power and involve development and management of large underground coal mines in Shanxi province. In transportation, work is proceeding on two railway projects and a second ports project to provide additional capacity. 29. In view of China's shortages of manpower with higher or technical education, the Bank will continue its support of education through a second agricultural education project and another university development project. Support of agriculture would continue through projects to provide rural credit with emphasis on improved project appraisal and institution-building, provide further assistance in agricultural research, and assist the Government in forestry. In industry, further loans will be made to the China Investment Bank, and there will be projects for technical renovation and modernization in industries such as fertilizers and machine tools. In health, a project will help improve rural health care services and medical education. Bank assistance is also planned for a rural water supply project. PART III - THE ENERGY SECTOR AND THE ELECTRICITY SUBSECTOR /1 30. China is the fourth largest producer and third largest consumer of commercial energy in the world. Coal is by far the most important source of commercial energy (70% of total production in 1982), but oil production has /1 For a broader discussion of the energy sector, see Bank Report No. 3391-CHA, entitled "China: Socialist Economic Development."  - 9 - increased rapidly since 1972 to become an important source of commercial energy (22% in 1982) and of export revenue (accounting for about one quarter of total export revenue). Natural gas, hydroelectric power and small quantities of shale oil and geothermal power constitute the balance of com- mercial energy. Noncommercial energy sources supply energy equivalent to about 40% of commercial production. Commercial energy production grew at 10.5% p.a. from 1952-1975, but the growth rate has fallen since then and between 1979 and 1981 total production declined by 2.1%. This trend was reversed in 1982, when there was a 3.8% rise in commercial energy production. About 20% of oil production and 1% of coal production are currently exported. 31. China's achievements in developing energy resources over the past three decades have been impressive. Production of coal has increased from some 60 million tons in 1952 to 666 million tons in 1982. During the same period, power generating capacity increased from about 2,000 MW to 72,360 MW. Oil production increased from about 0.1 million tons in 1950 to 106 million tons in 1979. These developments notwithstanding, the future prospects for energy supply remain uncertain. The major oil fields, which together account for about 90% of China's oil production, have peaked and entered a declining phase. In 1982, oil production fell to 102 million tons. No new discoveries have been made of a magnitude to offset this decline. Rapid expansion of the coal industry faces difficult problems in terms of investment, location and transportation. The remoteness of large hydro sites from load centers and the long gestation period of hydro projects preclude sizable increases in hydropower's share of energy production in the first half of the 1980s. Resource Endowment 32. China is well endowed with primary energy and has abundant resources in terms of coal, hydrocarbons, oil shale and hydropower potential. Coal and lignite reserves are concentrated largely in the north and northeast, which represent about 70% of the total recoverable reserves in China (600 billion tons). While future plans call for increasing coal production significantly by such measures as opening new mines and increased mechanization, transport (essentially railroad capacity) appears to be the single most important con- straint to achieving this objective. Proven recoverable reserves of oil are estimated at about 1.8 to 2.5 billion tons while the estimated probable reserves range from 5-10 billion tons in the onshore regions and 4-8 billion tons in the offshore areas. Recoverable gas reserves are about 130 billion cubic meters. Reserves of oil shale in China are estimated unofficially at 400 billion tons. Current production of shale oil from the Liaoning and Guangdong mines is about 300,000 tons p.a. China's exploitable hydropower potential, among the largest in the world, is estimated at 1.9 million GWh per year (present hydro generation is about 74,400 GWh). While geothermal phenomena are abundant in the mountainous southwestern part of the country, geothermal energy has not been developed to a significant extent in China and its role is likely to remain limited. As in other developing econo- mies, noncommercial fuels such as crop residue and animal waste are used extensively, especially in rural areas. China has pioneered and is now the leading producer of biogas.  - 10 - 33. China's energy resources are not evenly distributed. As much as 75% of the known commercial energy in terms of coal and oil is in the north and northeast, which have nearly 30% of China's population and more than 45% of gross industrial output. The east, with one-fifth of the total population and 30% of industrial output, is almost devoid of any energy resource. In the southwest, there is considerable hydropower and coal potential, but the central south is largely bereft of energy resources except for some hydro potential. Northwest China has considerable coal and oil resources but most of these are in such remote and sparsely populated areas that development would be extremely difficult and slow. Sector Issues and Policies 34. In rural areas, China has developed a large number of small coal mines, about 85,000 mini-hydro plants and innumerable biogas units. The mini-hydro stations, in particular, have made rural electrification possible on an extensive scale. In 1982, almost 90% of communes and 71% of brigades had access to electricity. However, China's level of commercial energy con- sumption is very high in relation to its economic activity. Indications are that there is substantial potential for improvement in industrial energy efficiency in China. The Government is well aware of this problem and is according energy conservation equal priority with increasing energy production. 35. Under the Sixth Five-Year Plan, the Government is putting major emphasis on the development of the energy and transport sectors. Although several coal and hydropower projects were postponed in 1981 because of over- all investment reductions, energy investment has been restored to the pre- viously planned level since 1982. Operations are underway to build a number of hydroelectric and thermal power stations, develop open pit and underground coal mines, and increase the capacity of transport facilities for coal handling. To accelerate petroleum development, the Government has invited foreign oil companies to explore and help develop both offshore areas and selected onshore areas with difficult drilling conditions. However, because of the long gestation period required for energy projects, it is unlikely that there will be any substantial increase in energy supply until the late 1980s. 36. In the short run, the Government is trying to ease the problem of energy shortages through energy conservation policies and programs. The measures comprise a mix of administrative and price incentives. Cutbacks in plan allocations of energy to major industrial users appear to have been the major factor thus far. Energy consumption norms have been reduced and more strictly applied. Some very inefficient plants have been closed down. Fifty-five energy conservation centers have been established to provide enterprises with technical assistance in improving energy efficiency. These programs have resulted in energy savings estimated at 35 million tons of standard coal equivalent in 1980 and 26.5 million tons in 1981. About half of these savings, however, might have been due to the shift in the industrial structure from heavy to light industry. There is still much potential for further energy-saving efficiency improvements in such industries as iron and  - 11 - steel, non-ferrous metals, chemical products, fertilizer and thermal power generation. Some price increases have also been effected. In 1979, the prices of coal and natural gas were raised. More recently, special subsidies on diesel fuel for certain users were eliminated, an excise tax of Y 70 per ton of crude and heavy oil (burned as fuel) was introduced and marginal coal prices to industrial users have increased. However, the present price structure is not fully conducive to energy conservation. Further increases in the price of coal combined with larger increase in the price of petroleum products for industrial users would be necessary. High industrial electricity rates would also encourage conservation and provide resources for capacity expansion, thereby helping to eliminate the chronic electricity shortage, which accounts for about 20% of losses in industrial production. The Electricity Subsector 37. The growth of the electricity subsector has been quite rapid. Installed capacity has grown at an annual average rate of about 12%, from 1,850 MW in 1949 to 72,360 MW in 1982. About a third of this capacity was in hydro plant and the remainder in thermal. Energy generation has increased by about 14% p.a. over the same period, from 4,300 GWh to 327,700 GWh. Annual per capita generation rose from 8 kWh in 1949 to 318 kWh in 1982. Most of this electricity is used for industry (75%) and agriculture (17%). 38. The basic strategy for the electricity subsector is to develop China's immense hydro resources and coal-based thermal stations. Accord- ingly, hydro development is being accelerated and coal-fired thermal stations planned. These developments will require extra high voltage transmission lines to transport power from remote sites to load centers and for intercon- nection between regions. Efforts are needed to improve fuel efficiency in thermal plants and to convert oil-fired units to coal-fired units. However, the energy subsector faces a number of constraints, the most important of which is a critical shortage of generating capacity, particularly in the Northeast, North and East China grids. This has severely curtailed indus- trial production in these regions. There is also a shortage of transmission and distribution facilities. No interconnections have yet been made between regions. This situation partly results from a scarcity of funds. The Government is beginning to address this problem by giving increased priority to financing many long-delayed power investments under the recently approved Sixth Five-Year Plan. However, a dearth of experienced mid-career engineers, inadequacy of construction and dispatch technology, and limited use of modern planning tools are holding back China's power development program. The Role of the Bank 39. The Bank's role in the electricity subsector will focus on transfer of modern technology, staff training, institution building with emphasis on system planning and long-term financial planning, and assistance in identi- fying cofinancing. Bank projects will introduce modern construction metho- dologies, instrumentation and control of system operation, training of staff on site and abroad, and technical assistance for more effective financial  - 12 - planning and management. Cofinancing has been arranged for the proposed project and continued efforts will be made to secure more cofinancing in all future projects. The Bank will also encourage the introduction of modern auditing procedures and international competitive bidding (ICB) especially for civil works. With Bank assistance, the Government has already developed and used interim guidelines for procurement of civil works through ICB. Use of ICB for procurement of both equipment and civil works will continue to be expanded as the Chinese staff gain more experience in using them. In the next few years, the Bank's lending in China's power sector will focus on hydropower developments, backbone transmission lines and mine-mouth thermal stations, all of which will involve the Bank more deeply in subsector planning issues. Institutions 40. Following the reorganization of China's State Council in 1982, there are three principal ministries responsible for the energy sector: the Ministry of Water Resources and Electric Power (MWREP), the Ministry of Coal Industry (MOCI) and the Ministry of Petroleum Industry (MOPI). MWREP over- sees all aspects of water resource management and electric power development including policy making, system planning, and the design, construction and operation of power and water resource projects of regional importance. Under MWREP, there are six regional power administrations which coordinate operations of the regional power grids and formulate long-term development plans for approval by MWREP and the State Planning Commission (SPC). Below the regional administrations are 16 provincial power bureaux operating as regional grids, while a further ten power bureaux still operate in isolation. The proposed project is located in eastern Yunnan Province near the borders of Guizhou Province and Guangxi Autonomous Region. The electric power system in Yunnan is administered by the Yunnan Provincial Electric Power Bureau (YPEPB) which will be responsible for operation of the Lubuge hydro station. The Yunnan Provincial Electric Power Bureau (YPEPB) 41. YPEPB, the proposed beneficiary, is responsible for the develop- ment and operation of the electric power system in Yunnan Province. It reports directly to MWREP in Beijing. It has 9 power generation and distri- bution enterprises, a dispatch center and two enterprises responsible for construction of thermal plants and transmission/distribution works. Day-to- day management is handled by a director who is appointed by MWREP after con- sultation with the State Council and provincial authorities. Major functions are controlled by five deputy directors. 42. YPEPB was first registered in Yunnan Province as a state-owned enterprise in 1949. However, no legal documents existed until recently evidencing the Bureau's legal status, powers and responsibilities. During appraisal of the project, this question was discussed with MWREP, YPEPB, and the Ministry of Finance (MOF). It was recognized that YPEPB's legal status needed to be regularized before it could sign a project agreement with the Bank. Accordingly, following the issuance of regulations governing all indus- trial enterprises in China, a charter clarifying the legal status of YPEPB was approved and issued by MWREP on November 10, 1983.  - 13 - 43. Hydropower developments are planned and coordinated by MWREP through its Water Resources and Hydroelectric Power Construction Corporation. Hydropower projects in China have historically been designed and constructed by organizations directed by the Ministry. Only on completion of construc- tion have the power bureaux assumed responsibility for them. In the case of Yunnan, the Fourteenth Construction Bureau (FCB) of MWREP is responsible for hydro project construction, and project design has been undertaken by the Kunming Hydroelectric Investigation and Design Institute (KHIDI). 44. YPEPB has a work force of about 23,500, of whom only about 6% have received technical training beyond secondary school level. For this reason, YPEPB has established an extensive training program to upgrade the basic education and skills of its staff. Since 1978, YPEPB has set up or re-established-a number of its own training institutions, which, however, are overcrowded and poorly equipped. Accordingly, a training component is included under the proposed project. Yunnan Power Market and Program 45. The Yunnan power system had a total installed capacity of about 1,270 MW at the end of 1982 - about 2% of the country's total. This system generated 5,360 GWh in 1982, of which about 47% was from hydro and 53% was from thermal plants (mainly coal-fired). The system comprises two grids, (central and southern), which are expected to be interconnected at 220 kV by 1985. 46. Energy generation in Yunnan has been growing at the rate of about 5.4% annually between 1972 and 1982. In the same period, peak demand has reached 916 MW, growing at an average rate of 5.7% p.a. Industrial users have accounted for 83.8% of the electricity consumed, with agriculture, transportation, and residential and commercial users accounting for 11.1%, 0.6% and 4.5% respectively. Based on an acceptable method of load project- ion, the peak demand and energy generation are expected to double between 1982 and 1991, with an average growth rate of about 7.7% and 8.0% p.a. respectively. The bulk of this growth will supply large new industrial loads e.g., for the Dukou steel mill, which is located in the southern part of Sichuan Province. 47. During the period 1982 to 1991, YPEPB plans to commission 1,150 MW of new generating capacity. Of this, 650 MW would comprise mine-mouth coal- fired thermal plants at Kaiyuan; the balance would come from hydro plants. The largest hydro project would be the proposed Lubuge plant, with an initial capacity of 450 MW. The total cost of YPEPB's 1982-91 investment program (including interest during construction) is estimated to be Y 3.9 billion ($2.0 billion). Financial Position 48. YPEPB has consistently achieved satisfactory financial results. Net income after taxes has grown from Y 99 million in 1978 to Y 112 million in 1982. Operating income produced rates of return on average net fixed  - 14 - assets ranging from a high of 13% in 1979 down to about 10% in 1982. Over the period under review, sales revenues and costs grew at an annual rate of about 3-5%. The downtrend in the rates of return was due mainly to higher depreciation expenses on the increased value of net fixed assets in opera- tion. Fixed assets have not been revalued, and no revaluation is being sought because of the low rates of inflation (averaging 1-2% p.a.) in China over the last 30 years. 49. YPEPB's balance sheets show no long-term debt, and until 1981, no equity capital and practically no retained earnings or depreciation. Most of the earnings and depreciation were remitted to the Government. Construc- tion was financed by government budgetary allocations made through the annual planning process. Working capital was also allocated by the Government. 50. YPEPB is a self-accounting entity but is bound by the financial regulations governing China's state-owned enterprises issued by MOF. Its production and investment plans, which form part of the consolidated annual plan of MWREP, are approved each year by SPC. Its financial accounts are prepared monthly, quarterly, and annually. A double-entry bookkeeping system is used, and income and expenses are accrued at the end of each financial reporting period. Although various organizations check YPEPB's accounts for their own purposes (e.g. MOF, Tax Bureau, local banks), no comprehensive audit is made. However, this situation has started to change since 1983 with the establishment of the State Audit Agency and the progressive establishment of provincial audit bureaux. Considerable progress has been made in drafting regulations and standards, and in educating and training officials. The Bank has assisted these bureaux by conducting a seminar to explain the Bank's requirements and guidelines for the audit of Bank projects; US$1 million has also been allocated for this purpose under a Technical Cooperation Credit (No. 1412-CHA). During construction of the Lubuge project, the Luoping branch of the People's Construction Bank of China (PCBC) will certify the project expenditures. Assurances have been obtained that YPEPB would have its annual financial statements and record of project expenditures audited by independent auditors acceptable to the Bank and submit them to the Bank within six months of the end of each fiscal year (draft Project Agreement, Section 4.02). The audit is expected to be performed by the Yunnan Provincial Audit Bureau. 51. One of the anomalies in China's financial system is the absence of long-term financial planning. During the preparation of the Lubuge project, the Bank furnished a financial forecasting model and assisted YPEPB and MWREP in preparing its first set of long-term financial projections. In the future, this will help YPEPB assess the impact of its expansion plans on its future financial position. Electricity Rates 52. Electricity rates in China have remained unchanged since 1952. They are reasonably uniform except in the northeast where they have been about 30% lower than elsewhere. The average tariff rate is about 6.6 fen  - 15 - per kWh (US