China - Tongbai Pumped Storage Project

Document of The World Bank Report No: 19796-CHA CN-PE-56424 PROJECT APPRAISAL DOCUMENT ONA PROPOSED LOAN IN THE AMOUNT OF US$320 MILLION TO THE PEOPLE'S REPUBLIC OF CHINA FOR TONGBAI PUMPED STORAGE PROJECT December 2, 1999 Energy and Mining Sector Development Unit East Asia and Pacific Regional Office  CURRENCY EQUIVALENTS (Exchange Rate Effective 11/27/99) Currency Unit = Yuan Y 1 = US$0.12 US$1 = Y 8.28 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS BERI - Beijing Economic Research Institute for Water Resources and Electric Power BOT - Build-Operate-Transfer CAS - Country Assistance Strategy CIF - Cost, Insurance, Freight CQ - Review of Consultants' Qualifications CRISPP - China Reform Institutional Support and Preinvestment Project ECEPDI - East China Electric Power Design Institute ECIDI - East China Investigation and Design Institute DC - Direct Contracting EIA - Environmental Impact Assessment EMP - Environmental Management Plan FIRR - Financial Internal Rate of Return FMIS - Financial Management Information System GAAP - Generally Accepted Accounting Principles IAS - International Accoumting Standards ICB - International Competitive Bidding IDC - Interest During Construction IERR - Internal Economic Rate of Return JPEPC - Jiangsu Provincial Electric Power Company LIB - Limited International Bidding MOEP - Ministry of Electric: Power MOF - Ministry of Finance PIP - Project Implementation Plan PSP - Pumped Storage Project RAP - Resettlement Action Plan SAA - State Audit Administration SETC - State Economic and Trade Commission SMEPC - Shanghai Municipa"l Electric Power Company SP - State Power Corporation ZPEPC - Zhejiang Provincial Electric Power Company ZPEPDC - Zhejiang Provincial Electric Power Development Company Vice President Jean-Michel Severino Country Director Yukon Huang Sector Director Yoshihiko Sumi Team Leader Barry Trembath/Ranjit Lamech  China Tongbai Pumped Storage Project CONTENTS A Project Development Objective ................................................................. 2 1. Project development objective ..................................................................2 2. Key performance indicators ..................................................................2 B Strategic Context ..................................................................2 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project ........2 2. Main sector issues and Government strategy ..................................................................2 3. Sector issues to be addressed by the project and strategic choices................................... C Project Description Summary ................................................................. 8 1. Project components ................................................................. 8 2. Key policy and institutional reforms supported by the project .......................................9 3. Benefits and target population ................................................................. 10 4. Institutional and implementation arrangements ............................................................ 10 D Project Rationale ..................................................................11 1. Project alternatives considered and reasons for rejection ............................................. 11 2. Major related projects financed by the Bank and/or other development agencies ........ 12 3. Lessons learned and reflected in the project design ...................................................... 12 4. Indications of borrower commitment and ownership ............................. ...................... 13 5. Value added of Bank support in this project ................................................................. 13 E Summary Project Analysis ................................................................. 14 1. Economic ................................................................. 14 2. Financial ................................................................. 15 3. Technical ................................................................. 15 4. Institutional ................................................................. 16 5. Social ................................................................. 16 6. Environmental assessment ................................................................. 16 7. Participatory approach ................................................................. 17 F Sustainability and Risks ................................................................. 18 1. Sustainability ........................................................... 18 2. Critical Risks ........................................................... 18 3. Possible Controversial Aspects ........................................................... 20  G Main Loan Conditions ................................................. 20 H Readiness for Implementation ................................................ 21 I Compliance with Bank Policies ................................................ 21 Annexes Annex 1. Project Design Summary ................................................ 22 Annex 2. Detailed Project Description ................................................ 24 Annex 3. Estimated Project Costs ................................................ 28 Annex 4. Power Sector Reform Strategy and Implementation Plan ........................................... 29 Annex 5. Organization Charts for Construction Management ................................................ 45 Annex 6. Economic Analysis ................................................ 48 Annex 7. Financial Summary ................................................ 52 Annex 8. Financial Management Assessment ................................................ 59 Annex 9. Procurement and Disbursement Arrangements ................................................ 63 Table A. Project Costs by Procurement Arrangements ................................................ 65 Table B. ICB Procurement Schedule ................................................. 67 Table B 1. Consulting Services Schedule ................................................ 67 Table C. ICB Procurement Arrangements .............................................. 68 Table D. LIB, IS and DC Procurement Arrangements .................... ............................ 69 Table E. Thresholds for Procurement Methods and Prior Review . ........................................ 70 Table F. Allocation of Loan Proceeds ................................................ 71 Annex 10. Land Acquisition and Resettlement ................................................ 72 Annex 11. Environmental Summary ................................................ 79 Annex 12. Project Processing Budget and Schedule ................. ............................... 93 Annex 13. Documents in Project File ................................................ 94 Annex 14. Statement of Loans and Credits ................................................ 95 Annex 15. Country at a Glance ................................................. 98 Map Number IBRD 30534  China Tongbai Pumped Storage Project Project Appraisal Document East Asia and Pacific Region Date: December 2, 1999 Team Leader: Barry Trembath/Ranjit Lamech Country Manager/Director: Yukon Huang Sector Manager/Director: Yoshihiko Sumi Project ID: CN-PE-56424 Sector: Power Lending Instrument: Specific Investment Loan Theme(s): Poverty Targeted Intervention: [ ] Yes [X] No Project Financing Data [X] Loan [ ] Credit [] Grant [ Guarantee [] Other [Specify] For LoanslCreditslOthers: Amount (US$m): Proposed terms: [] To be defined [1 Multicurrency [XI Single currency [] Standard Variable [] Fixed [X] LIBOR-based Grace period (years): 5 Years to maturity: 20 Commitment fee: 0.75% Service charge: Front-end fee on Bank loan: 1.0% Government IBRD 320.0 320.0 IDA ZPEPC and other equity investors 92.5 84.3 176.8 Industrial and Commercial Bank of China 407.3 407.3 Total: 499.8 404.3 904.1 Borrower: People's Republic of China Guarantor: Beneficiary: Zhejiang Provincial Electric Power Company Estimated disbursements (Bank FY/US$M): Annual 4.3 17.4 36.7 48.2 75.4 86.2 45.9 5.9 Cumulative 4.3 21.7 58.4 106.6 182.0 268.2 314.1 320.0 Project implementation period: 7 years Expected effectiveness date: May 1, 2000 Expected closing date: December 31, 2007 Implementing agency: Zhejiang Provincial Electric Power Company Contact person: Mr. Zhao Hubin Address: 2, Jinzhu Road (South), Hangzhou 310007, China Tel: 86-571-615-1166 Fax: 86-571-515-3979 E-mail: XISHJ@MAIL.hz.zj.CN OCS PAD Form: October 9, 1998  Page 2 A: Project Development Objective 1. Project development objective: (see Annex 1) The project has two objectives: (a) Increase peaking capacity and improve load following capability and power quality in the Zhejiang and East China power systems. The construction of a major pumped storage power plant, and the implementation of an efficient mechanism to price its output in the market will be undertaken to achieve this objective. (b) Improve the operating and invest.ment efficiency in generation by developing and implementing a competitive generation market in Zhejiang province. An associated objective is to ensure that the market structure created can easily transition to wholesale competition. The associated sector restructuring, regulatory capacity building and removal of transmission constraints will be undertaken as part of the project to achieve this objective. 2. Key performance indicators: (see Annex 1) (a) Improvements in load following capability will be measured by improvements in the Area Control Error (ACE). (b) The efficiency outcomes of the rriarket implementation will be measured by the reduction in the percentage of capacity contributed by small thermal units. The potential competitiveness of the generation market will be measured by a reduction in generation concentration (i.e. the capacity owned/managed by the largest market participant). Progress will be monitored by the adherence to an agreed implementation schedule for: separating and corporatizing generation stations; preparation of a market code and commencing market operation; and establishing a suitable oversight mechanism for market and sector regulation at the provincial level. B: Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: R98-107 Date of latest CAS discussion: May 28, 1998 Reducing infrastructure bottlenecks through expansion of power facilities, "capitalizing on major Bank role in sector in areas where private participation is unlikely for market reasons, while continuing to help China develop an improved policy framework and institutional capacity that will encourage greater private sector participation". 2. Main sector issues and Government strategy: (a) Impediments to Raising Finance for Large Generation and Transmission Projects. Meeting China's growing electricity demand requires an annual investment of about US$15-20 billion per year representing additions of about 12 to 15 GW of generation capacity and downstream transmission and distribution infrastructure. Remarkable progress has been achieved in diversifying financing sources and involving the private sector. It is worth noting that this has been possible largely owing to a retail tariff level that on average covers the full costs of supply. There are many privately financed independent power producers (IPPs) totaling about 11.5 IJW in commercial operation and 14 GW under construction. There are a number of publicly listed power generation companies in local and intemational stock markets (four companies totaling about 9 G'W listed in international exchanges and 21 companies listed locally). Despite the government's efforts to expand private capital for sector investments, there remain difficulties in financing transmission investrnents and large generation projects - particularly, hydropower/pumped storage plants which pose particular difficulties for private development. The impediments to raising capital for large generation and transmission projects are:  Page 3 (i) Insufficient capital market instruments and development to channel domestic savings into long- gestation projects and those with very long asset lives. In hydro the risk allocation models do not support private investment; (ii) Tariff surcharges which have been a major source of finance for sector expansion have been largely levied at the local level, leading to inappropriately sized local generation expansion. About half of the capacity added in recent years is in small inefficient units (100 MW and less). (iii) Lack of a transparent legal and regulatory system. (iv) Lack of a commercial framework and physical infrastructure to encourage power trading which would in turn allow the development of larger, economically sized generating units; <v/ An investment approval system which favors the development of small size generating units. (b) Transmission Bottlenecks. Transmission infrastructure in China has not been adequately developed to allow for efficient system development and supply cost minimization. Plants are not always iocated in regions where the overall system cost is minimized- some of the large plants constructed in areas close to load centers which require the transport of large quantities of coal on an overextended transport system, were not economically justified. The transmission bottlenecks continue to contribute to investment inefficiencies (lost economies of scale), location inefficiencies (overburdening of the railway system), environmental inefficiencies (heavy pollution burden on densely populated areas with limited local absorption capacity), and operational inefficiencies (uneconomic dispatch, higher losses). (c) Inadequate Wholesale Electricity and Transmission Pricing Systems. There are two significant shortcomings of the wholesale pricing system in the power sector in China. The first relates to the pricing of wholesale/bulk capacity and energy sales/purchases from generating plants. The second relates to the inadequate recognition of transmission as a separate service that needs to be separately accounted for in electricity tariffs. These inadequacies of wholesale electricity pricing are partially responsible for the inefficient utilization and dispatch of generating capacity. Inefficient resource use sterns from operation of old and/or small inefficient and therefore higher coal-consumption plants in lieu of modern, more efficient plants. The non recognition of the importance of transmission service is reflected in the inability, until recently, of utilities to include costs related to transmission in sales tariffs and to secure adequate investments for the transmission infrastructure. This is also impeding the implernentation of the purchasing agency model, and progress towards competition at the generation .evei. (d) Excessively Decentralized Distribution Operations. Electricity distribution, both network and retailing functions, are highly decentralized activities in China. For example, in Zhejiang Province alone .here are around 1,600 township and village level distribution operations, 66 county level distribution entities and 14 municipal power distribution entities. The advantages and disadvantages with the decentralized nature of distribution operations presents both challenges and opportunities. The advantages of this decentralization has been: widespread electricity access; consumer tariffs that on average cover all power supply costs; high bill collection rates and financial stability. The disadvantages of excessive decentralization has been: high technical losses (reportedly over 20%) and supply inefficiencies owing to the poor design practice in the low voltage distribution network; tariffs that vary substantially and in many instances are in excess of economic costs; tendency to rely on locally financed units which are generally uneconomically sized, inefficient and polluting. Changes in the organization and incentive structure of distribution operations is necessary to mitigate the large economic losses stemming from inefficient plants, system losses and the social impacts of ad hoc differences in consumer tariffs. (e) Complicated and Inappropriate Tariff Structures at the Consumer Level. The "new power new price" policy introduced during the early 1980s, together with legal and illegal surcharges levied at the provincial and local levels has had the desirable effect of raising overall tariffs to levels approaching (arid in some areas exceeding) long run marginal cost. However, these policies have left behind a legacy of consumer tariff structures which are complicated to administer; favor older inefficient industries over  Page 4 newer efficient ones; and unduly discriminate between user categories. (f) Unclear Corporate Relationships between Power Sector Entities. Currently power companies in China operate at three main levels: national, regional and provincial/municipal: (a) the provincial/municipal power companies are responsible for generation and transmission within a province or large province-level municipality (e.g. Beijing, Shanghai); (b) the regional power entities hold the central government ownership rights to, and are responsible for supervision of, several provincial/municipal power companies, and are also responsible for inter-provincial power transfers; and (c) the national power entity holds the central government's ownership rights in the regional entities and is responsible for inter-regional power transfers. However, this multi-layer relationship is not clearly and transparently reflected in the corporate governance. Commercial and financial transactions are still carried out according to administrative rules rather than market forces. Unclear ownership rights and inadequate corporate relationships between different power entities in China impede: (a) the full corporatization of power entities to meet the requirements of the Company Law; (b) the development of appropriate govemance at the three corporate levels; and (c) the commercial operations, financial independence, and profit orientation of the sector entities. (g) Excessive Reliance on Coal. China's heavy reliance on coal (especially for power generation) is expected to continue over the next two to three decades. Total installed capacity at end of 1998 was 273 GW, 76 percent of which is thermal capacity and the rest hydropower (23 percent) and nuclear power (less than one percent). The existing generation capacity is over-weighted towards base load plant particularly in coastal provinces where untapped hydropower resources are dwindling, and has, as noted above, a large proportion of generating capacity in small power plants which are often coal fired. (h) Low Efficiency of Electricity Supply and Use. Improvement in energy efficiency in China is clearly indicated by the sustained low elasticity of demand to GDP growth: 0.86 during 1980-97. However, the potential for electricity conservation on both the supply and demand sides is still high. The government is now promoting programs to reduce losses on the supply side and market-based initiatives to improve electricity use. Government Strategy. The Government's strategy seeks to implement reforms on multiple fronts. The main elements of the Govemment's strategy to address the above problems are: (a) Completely separating generation from transmission and distribution functions. This strategy is being aggressively implemented in many provinces -- all vertically integrated provincial power companies have been required to define a strategy to separate generation assets. (b) Introducing competition at the generation level within provincial power systems, and developing regional power markets for inter-provincial trade. (c) Establishing formal regulatory mechanisms at the Central and Provincial Government levels. This follows from the abolition of the Ministry oif Electric Power in April 1998, and the transfer of its government regulation/supervision functions to the State Economic and Trade Commission (SETC). (d) Developing sound corporate govemance practices for state-owned power corporations and clarifying the relationships between national, regional and provincial level companies. (e) Expanding and mainstreaming successfully strategies to raise private capital - including: (i) BOT projects with full foreign ownership developed through competitive bidding; (ii) joint investment projects with foreign investors; (iii) domestic and foreign equity listing of power enterprises; and (iv) securitization of existing generation assets to raise capital from private sources. (f) Mitigating the environmental impacts of a coal dominated power system by: (i) developing hydropower and other renewable energy resources, and pumped storage plants in areas where hydro resources are depleted; (ii) requiring the mandatory retirement of around 10 GW of small inefficient and polluting coal fired thermal units by year 2000; and (iii) using SO2 emission taxes and requiring flue gas desulphurization technologies. (g) Increasing energy supply efficiency by: (i) reducing operating losses in generation, transmission  Page 5 and distribution; and (ii) expanding demand side management through pricing and energy conservation measures. (h) Rationalizing wholesale generation tariffs and transmission tariffs, consistent with the complete separation generation from the transmission and distribution assets. (i) Rationalizing consumer tariffs, including the rolling in of existing surcharges into a unified tariff structure, and the banning of future surcharges (j) Providing a fiscal package of government backed long-term debt to finance distribution investments to improve the quality of the low voltage network and allow for higher levels of demand. 3. Sector issues to be addressed by the project and strategic choices: Status Review in Zhejiang Province Project Influence on Specific Sector Issue Sector Issue (a) Impediments to Raising Finance for Large Generation and Transmission Projects Zhejiang province has been reasonably The project directly supports the financing of successful in financing thermal generation capacity. transmission and generation infrastructure required There remain financing constraints for to meet future electricity demand. Private transmission, pumped storage and distribution financing for the pumped storage scheme is not investments. On the generation side the province feasible in the near future for reasons set out in has completed the international listing of a thermal Annex 5. generating company -- the Zhejiang South East Electric Power Company. A number of joint- Eventually with the development of a competitive venture IPPs are in operation and two foreign generation market, the price determination financed IPPs were recently signed. However, a mechanism will make these small sized units large proportion of the thermal capacity additions unattractive and will lead to their gradual phase- have been small plants. The incentives leading to out. small unit sizes being chosen have been recognized and the province has now: (i) banned new additions of small sized thermal units; (ii) restricted them to be used to generate during peak periods; and (iii) ordered the retirement of small units as loans are repaid. Sector Issue (b) Transmission Bottlenecks ZPEPC has been reasonably successful in The investment component in the project will ease expanding its 500 kV network, much of it transmission constraints that prevent adequate supported under previous Bank projects. However, transfer of power to load centers, despite the transmission constraints are still contributing to availability of generation capacity. In addition, lower than optimal hours of operation on more easing these transmission constraints will also efficient thermal units and the continued use of facilitate the development of a power market in more inefficient units that are closer to load Zhejiang province. centers. In addition there are circumstances when load has had to be shed despite the availability of generating plant to meet this load. In effect the lack of adequate transmission infrastructure prevents efficient system expansion and power market development. Sector Issue (c) Inadequate Wholesale and Transmission Pricing Structures Zhejiang has pioneeredthe implementation of a The project will support the development of a two-part generation tariff that has partly addressed competitive generation market in Zhejiang which  Page 6 Status Review in Zhejiang Province Project Influence on Specific Sector Issue the inefficiencies associated with a one-part tariff. would overcome the key limitations of the This tariff system and operating rules are referred Analogue Electricity Market. This will lead to the to as the Analogue Electricity Market. Howvever, gradual phase-out of small inefficient plant, and the continued use of a minimum capacity factor facilitate the optimal operation and expansion of benchmark (i.e. 57%) in the Analogue Electricity the system. In addition, the restructuring of ZPEPC Market remains a problem to achieving higher to separate transmission from generation will create efficiency gains. On the transmission front there is the framework necessary to identify transmission no viable means to recognize and recover costs and investment needs and ensure adequate transmission costs, which impedes transmission recovery. system expansion. Sector Issue (d) Excessive Decentralizationi of Distribution Operations Zhejiang has a very fragmented distribution sector, Under the project work will be initiated to assess with 14 municipal (or prefectural) distribution options for the restructuring distribution operations. bureaus, 66 county-level power companies, 1,674 The intention of this work is to preserve the township distribution units and 40,000 village level advantages of the decentralized operations in the distribution units. The township and village sector, while implementing incentives that will lead distribution units are collectively owned and the to efficient network development and service rest have differing levels of local, provincial and delivery. Training programs to improve the central government ownership. There is a need to management of these distribution operations will improve the management and commercial practices also be defined. of this entities. In addition, there are problems with the network quality and the maximum demand capacity of the distribution system. Sector Issue (e) Complicated and Inappropriate Under the project, cross subsidies will be phased Tariff Structures at the Consumer Level out and structure will be further refined, and tariff ZPEPC has obtained agreement on a unified tariff setting principles in competitive market schedule with provincial regulatory authorities enviromnent defined. (pricing commission, and economic and planning commission). This rolls in all surcharges, has an average level of 59.5 fen including VAT and includes minimum cross subsidies, which will be phased out over three years. The schedule has been submitted to central government for approval. Sector Issue (f) Unclear Corporate Relationships between Power Sector Entities The institutional components in the project will Although a number of generating plants that are make the relationships between generation partly owned by ZPEPC have been established as enterprises and the ZPEPC core holding company independent corporations, there remains tacit more commercial and transparent. Adequate control exercised by ZPEPC headquarters which provisions are expected to be built into the impedes the development of truly independentl structures and charters to ensure management commercial enterprises. independence at the generation company level. Sector Issue (g) Excessive Reliance on Coal About 83% of the energy generated in Zhejiang Both the investment and institutional components comes from coal-fired units, of which about 40% in the project will have a huge impact in reducing comes from small inefficient units. As a the intensity of coal use. The development of a consequence of this the average specific coal competitive generation market will lead to the  Page 7 Status Review in Zhejiang Province Project Influence on Specific Sector Issue consumption in Zhejiang is in the order of 404 increased use of more efficient plant and thereby gce/kWhr, in comparison to an average lead to lower coal usage per kWh of energy consumption of about 320-340 gce/kWhr on more produced. The pumped storage plant, while not efficient generating plant. directly reducing the use of coal generation will ensure more efficient use of coal by displacing inefficient coal units used for peaking, as well as increasing the load factors on existing large thermnal units (e.g. Beilingung) thereby improving average heat rates.  Page 8 C: Project Description Summary 1. Project components: (see Annex 2 for a. detailed description and Annex 3 for a detailed cost breakdown) Indicative Bank- % of Component Sector Costs % of financing Bank- (US$M) Total (US$M) financing 1. Tongbai Pumped Storage Power Physical 405.3 44.8 214.8 67.1 Plant. The development, based on an existing upper reservoir, consists of: (a) a new lower reservoir impounded by a dam with a maximum height of 68.3 m, (b) two inclined shafts and tunnels with a total length of 1270 m to connect the upper and lower reservoirs, (c) an underground powerhouse with an installed capacity of 4 x 300 MW, (d) implementation of an environment management plan, (e) implementation of a resettlement action plan including resettlement of 165 project affected households, and (f) consulting services to assist in engineering, design, procurement and construction management 2. Transmission Reinforcement Ph,ysical 329.2 36.3 92.0 28.8 comprises (a) erection of twin 500 kV transmission lines (110 km long) connecting the Tongbai plant to the 500 kV grid at Zhuji and the construction of a 500 kV substation at Zhuji; (b) construction of two 500 kV substations at Xiaoshan and Yongxi, each with a capacity of 750 MVA; (c) expansion of existing substations at Ningbo and Wenzhou by 1,000 MVA each and the erection of a 500 kV transmission line, 275 kIn long, between the two substations, (d) erection of three short 500 kV double-circuit transmission lines connecting substations at Zhuji, Yongxi and Xiaoshan to existing transmission lines; (e) supply and installation of associated telecommunication and dispatch automation equipment; (f) implementation of distribution management systems in Hangzhou and Ningbo; and (g) development of province wide customer service centers;  Page 9 Indicative Bank- % of Component Sector Costs % of financing Bank- (US$M) Total (US$M) financing 3. Implementation of a program of Institutional 10.0 1.1 10.0 3.1 power market development and Development sector restructuring, through (a) implementation of a competitive power market in Zhejiang; (b) restructuring of ZPEPC with a view to separating generation from transmission functions, including the incoiporation of power generation entities in Zhejiang as limited liability companies; (c) consolidation of decentralized and fragmented distribution operations into county-level distribution entities and the incorporation of such entities as limited liability companies; (d) development and implementation of a regulation framework and establishment of a provincial regulatory authority in Zhejiang; (e) implementation of an office automation system and an enterprise resource planning system in ZPEPC; (f) studies dealing with customer relations, generation planning, retail tariff design, condition monitoring and maintenance; and (g) training of ZPEPC staff in business admiinistration, corporate governance, condition monitoring and maintenance, power market management, distribution management, power station technical and commercial operation and utility management. Total 744.5 82.2 316.8 99.0 Total Project Costs Interest during construction 156.4 17.5 0.0 0.0 Front-end fee 3.2 0.3 3.2 1.0 Total Financing Required 904.1 100.0 320.0 100.0 2. Key policy and institutional reforms supported by the project: The key policy and institutional reforms to be sought under the proposed project include: (a) Implementation of a competitive generation market, based on a Single Buyer operating a mandatory balancing pool. The main features of the market and its implementation are described in Annex 4, Section C. The market design introduces an innovative incentive market structure which will facilitate: (i) competition amongst generators for dispatch leading to the efficient use of available generation capacity; (ii) the efficient procurement of new generation capacity; (iii) the gradual and smooth transition to wholesale competition; and (iv) acquisition of commercial skills and capabilities by participants to operate in an increasingly competitive environment. (b) Developing and establishing a regulatory framework and institutional mechanism for the oversight of the market and the power sector. (c) Complete separation of generation assets from transmission and distribution and restructuring of existing generation assets into independent generation companies (by 2000);  Page 10 (d) Corporatization of county level distribution bureaus into limited liability companies (from 1999 to 2003) (e) Developing mechanisms to facilitate power exchange and trade with other provincial power companies in the East China region. (f) Irmiplementing a mechanism for pricing ancillary services, particularly peaking capacity provision. 3. Benefits and target population: The Project would have a marked impact onI the economic development of the province and, to a lesser extent, the East China region by mitigating and eliminating institutional and technical constraints that have prevented the power system from expanlding and operating efficiently. The direct benefits attributable to the project are: (a) Increase in least cost peaking capacity to accommodate increased peak load and help redress the imbalance in power capacity mix towards base load plant. (b) Improved system capacity factor that will increase the efficiency of coal use. (c) Improved load management and load fol lowing capability that will increase service quality in terms of supply reliability and frequency regulation. The power market and regulatory system development supported by the project is ultimately aimed at increasing sector efficiency by initially introclucing generation competition, which may later be expanded to the wholesale level. Given the size and strategic importance of Zheiiang province the lessons learned will i.nfluence power sector reforms in China as a whole. The project will facilitate: (d) the implementation of an innovative competitive generation market structure (e) restructuring and corporatization of one of the largest provincial power companies in China, providing lessons for deeper state enterprise reform in the power sector. (f) the establishment of a regulatory mechanresm for oversight of the power market and the sector mn Zhejiang Province. Implementation of the investment components of the project will also directly benefit the people in the project areas by providing (i) employment opportunities both at the construction and the operation stage, (ii) economic development opportunities because of a need for local services and materials, and (iii) tax revenues. 4. Institutional and implementation arrangements: Implementation Period. Seven (7) Years, from 2000-2007 Executing Agency. ZPEPC would be the executing agency of the project. ZPEPC is an experienced executing agency through three Bank financed projects: Beilungang Therrnal Power Plant I and II (completed and rated satisfactory), and Zhejiang Power Development Project (ongoing and rated highly satisfactory for implementation progress and satisfactory for development objectives). ZPEPC has quaalified personnel to undertake project preparation, implementation and operation. The power market and regulatory system development component would be executed by ZPEPC in close coordination with East China Electric Power Group Corporation (ECEPGC) and with oversight from the State Power Corporation (SP). Project Coordination. ZPEPC would be responsible for overall coordination of the Project. Project Oversight and Policy Guidance. The reform elements of the proposed Project will be supervised by SP. The SP would be expected to obtain State Council approvals on major reform! issues. The Ministry of Finance (MOF), the State Development Planning Commission (SDPC) will supervise Project financing and advise ZPEPC on all financing matters. The concerned provincial govemment agencies will oversee the planning and implementation of resettlement.  Page 11 D: Project Rationale 1. Project alternatives considered and reasons for rejection: The proposed Tongbai Pumped Storage Plant is the chosen first investment resulting from a least cost power system development study prepared for the Zhejiang power system by the Beijing Economic Research Institute (BERI). The study derived optimal (least cost) capacity additions to the system until year 2015 to meet demand which is forecast to increase almost five-fold between 1997 and 2015. Peak load is expected to grow from 6500 MW in 1997 to about 32,000 MW in 2015, requiring addition of almost 22,000 MW to the system. The study found that the optimal composition of new capacity includes about 4360 MW of pumped storage plants (PSP), including ZPEPC share in the Tianhuangping PSP (450 MW ) under construction. Due to a considerable deficit of peaking capacity in the system (the existing generation capacity is overweighted towards base load), the demand for PSP is extremely high. Even with the two currently identified PSP (Tongbai and Wulongshan) developed at their earliest commissioning dates (Year 2002 for Tongbai and 2003 for Wulongshan), a further 2900 MW of PSP would need to be put into operation during the period of 2004-2015. One of the major alternatives considered was to install gas turbines burning distillate. These would be the most economical alternative for peaking operation in the absence of economical pumped storage. However, while gas turbines are capable of meeting the peak, they are not capable of providing additional load during off-peak periods thus improving the efficiency of thermal generation. In the least cost analysis, gas turbines were selected as candidates for system addition. About 400 MW of gas turbines would be installed for the period (2000-2001) before the Tongbai PSP comes on line. After 2002, addition of substantial capacity of gas turbines was not found to be economic. Hydropower with sufficient storage to provide seasonal regulation was also considered as an alternative to PSP. However, there is no significant undeveloped hydro resources in the province or even in the East China region. There are only two remaining sites with significant potential within the province. These are the Tangkeng cascade plants with installed capacity 3 x 200 MW and Huaguantan 60 MW + 25 MW. The least cost plan indicated that Tangkeng should be put into operation in the same year as Tongbai PSP but Huaguantan should not be commissioned until 2005-2010 because of its high capital cost. The earliest available hydropower import would be in year 2005 from Three Gorges which would largely operate as base load plant. Other expansion candidates considered were combined cycle gas turbines, coal fired thermal units, and nuclear units. However, they are only suitable for base load generation. The proposed transmission reinforcement also constitutes part of the least cost plan of the 500 kV Zhejiang provincial power grid. The plan was prepared using the same concept and methodologies adopted by ZPEPC based on the technical assistance for transmission and distribution planning under the Zhejiang Power Development Project. Load flows, stability studies and short circuit calculations were carried out using the PSS/E software package. A number of strategic options for transmission development in the province were formulated and investigated under various load forecast, generation siting and dispatching scenarios.  Page 12 2. Major related projects financed by the Bank and/or other development agencies: (completed, ongoing and planned) Latest Supervision (Form 590) Sector issue Project Ratings (Bank-financed projects only) Implementation Development Progress (IP) Objective (DO) Bank-financed Issue a,b,c,e,f East China (Jiangsu) Power Transmission S S Project - o Issue a,b,e,f Tianhuangping Hydroelectric Project - o HS S Issue a,b,c,d,e,f,g Zhejiang Power Development Project - o HS S Issue a,b,c,f Shuikou Hydroelectric Project - c HS HS Issue a,b,d,f Second Shuikou Hydroelectric Project - o HS HS Issue a,b,c,f Ertan Hydroelectric Project- c HS HS Issue a,b,c,f Ertan Hydroelectric Project Phase 2 - o HS S Other development agencies Asiar Development Bank Guangzhou Pumped Storage Stage II Project (Loan No. 1242-PRC) - o ADB (TA N4o. 2789-PRC) Strengthening Demand Sidie Management in Guandong and Zhejiartg Province - o IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) 3. Lessons learned and reflected in the project design: Several lessons drawn from the previous three Bank financed projects in the province and completed and on-going power projects in other parts of China and the world have been incorporated in the project design and in the preparation phases to date. These are: (a) Coordination of Bank supported activities for sector reform through economic and sector work and project lending. In design and preparation for the power market and regulatory system development component of the project, a. close coordination has been maintained with the IDF financed sector reform study (which aims at setting up a policy framework for power market development in China)and the East China (Jiangsu) Power Transmission Project (which includes a component to develop power trading at the regional level within East China). The coordinated approach ensures consistency and maximizes the likelihood of replication of successful reform efforts throughout China. (b) Efficient procurement management through prequalification and/or staged bidding. Most procurement problems which have occurred in China over recent years have been related to the qualification of bidders and offered equipment, in an environment where fully qualified bidders are continually increasing the proportion of rnanufacture by subsidiaries, joint-venture partners and subcontractors who are not themselves fully qualified. In addition, in information technology related equipment, fast developing technology results in difficulties in defining which technology qualifies. To a large extent, these difficulties can be avoided through prequalification or staged bidding processes and it has been agreed that prequalification will be adopted for the generating unit package for the Tongbai plant and for IT components. Another difficulty which has resulted in delays in power plant equipment installation in China relates to interfaces between individual suppliers. Procurement packaging has therefore bee.n designed to reduce the number of packages to the minimum practicable level while encouraging worldwide competition. For civil works construction, which is planned to be carried out by local contractors, experience has been mixed. Therefore, ZPEPC has carried out a prequalification process for local contractors selecting only six of the most qualified bidders specialized in the field of hydroelectric construction.  Page 13 (c) Need for early government approval of project. In recent power projects there were delays in project processing stemming from delayed internal Government approvals. These delays arose from inadequate counterpart funding sources and delayed approval of feasibility studies etc. In the current case, there is no shortage of counterpart funds and the project proposal incorporating all three components has been approved by the State Council. Approval of the final feasibility study (including foreign funds utilization request) may still be on the critical path to negotiations (d) Need for adequate resettlement planning, consultation and monitoring. The numerous lessons learned in several of the large Chinese reservoir resettlement projects (Shuikou, Ertan and Daguangba) are being brought to bear in the limited resettlement associated with Tongbai. The transmission line resettlement process will continue based on the highly successful organization and procedures developed under the Zhejiang Power Development Project. 4. Indications of borrower commitment and ownership: The core component of the project (Tongbai Pumped Storage Power Plant) has been identified by ZPEPC as a top priority development for providing peaking capability to the East China region to meet the growing demand and to improve the power quality. In East China, Tongbai was chosen as the next pumped storage project after a central government arranged independent comparison of competing candidates. The approval of the project proposal incorporating all three components, by State Council, at a time when investments in new generation are being severely restricted demonstrates the commitment of the government to the project. Regarding the reform component of the project, the East China region and, in particular, the provinces of Shandong, Shanghai and Zhejiang have been chosen by the central government to experiment on various aspects of power sector reform. Zhejiang has been chosen to pilot the implementation of power markets at the provincial level. ZPEPC has already installed meters at major IPP power plants which will enter first into the power market and conducted trials with an internal market. They have also completed a draft of the market code and development of settlement software. Trial operation of the market is expected to commence in early 2000. The project has also obtained support from the (SP) and the State Economic and Trade Commission (SETC) and the provincial government for regulatory system development. 5. Value added of Bank support in this project: Development of the power sector is vital for the development of industry and commerce to sustain a high rate of economic growth and to distribute the benefits of economic growth to all groups of society and the physical components of the project will support this goal. Power sector reform and institutional development which is being achieved through Bank involvement in the sector are ultimately aimed at developing the power sector from one which initially represented a substantial drain on public finances, to one which will expand and operate in response to market forces and support public finances through taxes and through the attraction of foreign investment to the country. Experience in China and in other countries has also shown that power sector reform tends to pilot widespread state owned enterprise and governance reform as well as development of the financial sector. Bank involvement in the power sector in Zhejiang has closely paralleled Bank involvement in the Chinese power sector, with Zhejiang often piloting the reform process. Achievements to date have been substantial but the remaining agenda is formidable. The investment components are appropriate vehicles for Bank investment in that private sector development is not appropriate. While a few transmission lines have been developed privately on a lease back basis, this is inappropriate in China where the power law provides that the transmission network should be owned by the state. Hydroelectric and pumped storage projects are difficult to develop privately because of: the high proportion of civil costs which do not attract export credits; their capital intensive nature with costs being recovered over a design life five times the maturities of commercial loans; the longer construction period; the higher cost estimate risk because of geological uncertainties and the high proportion of local costs which can rise rapidly in fast changing political, economic and social environments; and environmental and resettlement implications which deter private developers and lenders. A recent survey of privately developed greenfield projects reaching financial closure since 1991  Page 14 revealed only 1400 MW of hydro projects, some three percent of privately developed capacity. Half of this was in a single project in Turkey where there was a high degree of risk pass-through. The others dozen or so are small (average 55 MW), and carefully selected so as to minimize hydro-specific risks listed above. There are no pumped storage projects. An additional difficulty of pumped storage projects is the pricing of ancillary services (quick start system reserve, primary, secondary frequency regulation and voltage regulation). For this reason, all pumped storage plants developed to date have been developed publicly and owned (or leased to) the grid. This aspect is even more difficult in competitive power markets, as will be introduced in Zhejiang. For instance in the United States, two pumped storage plants which were to be developed privately, to be leased to utilities, have been put on hold until the issue of pricing of ancillary services has been solved. World Bank involvement in the project would ensure that: (a) The design and implementation of the power market in Zhejiang, which is a central theme of the proposed project, benefits from international experience in the development of power markets. The Bank is in a unique position to bring international experience to bear in power market design in such areas as market organization and operation; settlement systems; ancillary services pricing and transitional arrangements. (b) The pioneering work related to the detailed design of an electricity regulatory system in Zhejiang Province will provide a key input to the central govemment decision-making process in delineating central and provincial level regulatory responsibilities and institutionalizing them. (c) The legal and commercial arrangements defining the relationship if the pumped storage plant with the power market are appropriate. (d) The technical design, construction practices and equipment selected for the pumped storage hydro plant are in accordance with leading international practice and standards. China has limited experience in these areas of pumped storage hydro plant development and this project would significantly contribute to capacity building. (e) The on-going policy dialog to address the institutional aspects of wholesale electricity pricing and transmission pricing, are successfully implemented in leading provincial power systems that are likely to serve as models for other provinces. E: Summary Project Analysis: 1. Economic: (supported by Annex 6) [X3 Cost-Benefit Analysis (Pumped Storagle Component): NPV=US$152.9 million; ERR= 16.0% [XJ Cost Effectiveness Analysis (Transmission Component): NPV=US$57.0 million; ERR=15.4% [ ] Other (specify) A least cost analysis (cost effectiveness analysis) was carried out to verify that the Tongbai Pumped Storage Power Plant forms part of the least cost generation expansion for Zhejiang Province. This proved to be true under a wide range of assumptiorns. A benefit/cost analysis was also carried out using currently demonstrated willingness to pay as a minimum proxy for economic benefit. This analysis yielded an EIRR of 16 percent. An additional analysis was carried out to determine the effect of dynamic benefits on the rate of return. This analysis showed that the system is currently adequately supplied with fast ramping capacity to maintain frequency in a rational range. However, improvements in system reliability would raise EIRR from 16.0 to 16.3 percent. Full details including sensitivity studies and. risk analysis are included in Annex 6. 2. Financial: (see Annex 7) The Tongbai pumped storage plant is a joinrt investment by ZPEPC, East China Power Group  Page 15 Incorporated, Shanghai Electric Power Company, and the power investment companies of Zhejiang and Jiangsu Provinces, Shanghai City and Tiantai County. The power plant will be formed into a limited liability company prior to commencement of operations. According to a pre-investment agreement, the capacity available from the power plant will be distributed to the provinces and municipality in which the shareholders are located in proportion to their aggregated capital contributions, and the shareholders shall be responsible for the purchase of the on-grid quantity and provision of pumping electricity. The investors have agreed to pay a two part tariff for capacity and energy which will allow the company to meet its financial obligations and to provide the investors with a 12 percent internal rate of return on equity invested, which may be adjusted upwards in the event of a resurgence of local inflation. Financial analyses were therefore carried out to determine the tariff profiles required to provide this rate of return, under different scenarios of pumrping energy costs and annual generation. These analyses demonstrated that the average tariff required to provide these rates of return is less than currently being paid for thermal peaking plant. Analyses were also carried out to determine likely rates of return on investment and equity under competitive conditions. Under the base case scenario, the FIRR after tax is 15.8 percent and IRR on equity (net cash flow after tax) is equal to 25.2 percent. A financial management assessment of ZPEP was carried out as part of the project preparation, and is included as Annex 8. Based on this assessment the task team determined that the Project will satisfy the Bank's financial management requirements as stipulated in OP 10.02. The project will have in place an adequate project financial management system that can provide with reasonable assurance, accurate and timely information on the status of the project in the reporting format agreed with the proposed project management office and as required by the Bank. 3. Technical: Tongbai. The project has been designed and will be implemented according to internationally accepted technical criteria and standards. The technologies involved are proven, and as demonstrated by other completed and ongoing pumped storage projects (including the Bank financed 1800 MW Tianhuangping Pumped Storage Project), have been successfully used in China. The project designer, East China Investigation and Design Institute (ECIDI) is one of the most experienced design institutes in China and is ranked first among the 13 design institutes under the direct jurisdiction of SP. They are also the designers of the Tianhuangping project. International consultants have been employed to review designs, prepare technical specifications for international bidding, and assist in preparation for construction. Prequalification will be undertaken of contractors for the major civil works package and for the powerhouse generating equipment. With regard to the latter, prequalification criteria have been agreed and applications will be invited in December 1999. There is more than adequate knowledge on site conditions (notably geology) due to the combination of the construction experience from the existing hydro project at the site, plus extensive site investigations for the new project. The underground powerhouse and waterways are largely located within a strong, granite rock strata. A Special Board of Consultants has been formed to carry out periodic independent reviews of technical aspects of the design and construction of the pumped storage plant including the associated dams, in conformity with OP 4.37. Transmission Component. The component has been designed by the East China Electric Power Design Institute (ECEPDI), Southwest China Electric Power Design Institute, and Zhejiang Electric Power Design Institute, who have been qualified by SP. In preparation for the project, ZPEPC employed international consultants to prepare standard technical specifications which will now be used for all high voltage transmission procurement in Zhejiang Province. Cost estimates for equipment are based on recent international bids and cost estimates for works on recent local bids. Physical contingencies have been allowed for at rates of 15% for underground works, 10% for other civil works, 5% for electrical and mechanical equipment, and 10% for miscellaneous. Price contingencies have been calculated based on 4.0% local inflation, and 2.4% foreign inflation. The  Page 16 agreed procurement and disbursement arrangements are presented in Annex 9. 4. Institutional: ZPEPC is very experienced in Bank projects, this being their fourth project. This is demonstrated by the rating for the ongoing Zhejiang Power Deve,.opment Project, which is rated Highly Satisfactory in relation to implementation progress. Organization charts for construction management of the two physical components are included in Annex 5. For the pumped storage project, ZPEPC will engage a supervising engineer, from the shortlist of highly qualified firms certified by the Ministry of Construction for works of this type and magnitude. International consultants will also provide advisory services to this firm and ZPEPC. For the transmission component, ZPEPC will continue with the implementation arrangements successfully used for the 500 kV transmission component of the Zhejiang Power Development Project. 5. Social: The pumped storage power plant will require acquisition of 1,282 mu of land, some 606 min is related to the reservoir, with the remainder relating to construction of the dam, roads, waterway, switchyard and other related facilities Additionally, during construction, a total of 806 mu land area will be temporarily occupied for construction facilities, living quarters and temporary access roads. Based on a census survey, a total of 354 households and 1,283 persons will be affected by the project, of which 165 households of 572 persons will be physically relocated, while the remaining 189 households of 711 persons will only lose land The project will also have minor effects on an irrigation canal, power and communication lines and local roads and bridges. The transmission component will require acquisition of some 718 mu, 437 mu of which is for the three new substations with the remainder for tower bases (some 0.6 mu per km). Temporary occupation of about 255 mu of land will also be required for the transmission lines. Based on a detailed survey, 104 households of 449 persons will need to be relocated; and another 145 households or 626 persons will be affected due to land loss. The basic resettlement strategy is to provide land based economic rehabilitation for those who lose land. Those who lose their houses will be provided with replacement value, free new housing plot and moving assistance. Detailed resettlement action plans (RAPs), fully conforming to OD 4.30 have been prepared for both power plant and transmission components. These are summarized in Annex 10. 6. Environmental assessment: Environmental Category [X] A [ ] B [ ] C The pumped storage plant exploits an existing upper reservoir built in the 1960s. A new lower reservoir is to be built, together with an underground powerhouse. Both reservoirs are small with surface areas of 79 ha(upper) and 48 ha(lower) and are sited orl small streams. The reservoirs will act as transfer ponds with sufficient storage for a daily operating cycle. The transmission lines primarily extend through relatively undeveloped mountainous terrain. As a result only some 4 ha of agricultural land will be lost. The three new and two extended substations are located in generally developed areas. An environmental impact assessment (EIA) and an environmental management plan (EMP) conforming to OP 4.01 have been prepared and are summarized in Annex 11. The most important impacts are: (a) Loss of the Baizhang valley (50 ha) by inundation to forn the lower reservoir; (b) Potentially adverse impacts on the downstream flow regime in the Baizhang River by releases from the lower reservoir; (c) Loss of a small area (30 ha) of wetland in the area assigned for conversion to resettlement; (d) Short-term impact of the influx - to a rural area - of up to 3800 workers during construction of the pumped storage plant; 1.0 ha= 15 mu  Page 17 (e) Some tree cutting and vegetation clearing in the forested area (600 ha) crossed by the transmission lines; (f) Electromagnetic radiation and corona noise from the transmission lines and substations; (g) Construction of some 38 km of access roads for the transmission lines, mostly through mountainous and forested areas. One of the most significant mitigation measures taken has been the consideration of environmental impacts during the formulation and design of the project, particularly in relation to location and alignment of the transmission lines and substations. The criteria applied include the following: avoidance of all areas of prime ecological significance; avoidance of areas of archaeological and historical significance; avoidance of areas of significant scenic or tourism value; avoidance of areas liable to adversely impact safe operation, e.g. unstable slopes, seismically active zones, flooding, heavy icing etc.; avoidance as much as possible of populated areas, agricultural land, and existing infrastructure. With regard to environmental management, among the construction practices specified are: use of appropriate drainage, collectors and settling basins to prevent surface water contamination; treatment of waste disposal areas; prohibition of hunting or any abuse of the local fauna by the workforce. As a response to the loss of wetland used for resettlement, a very much larger area, about 853 ha, is planned to be set aside as a nature reserve. 7. Participatory approach: a. Primary beneficiaries and other affected groups: The preparation of the project has involved and will continue to involve all major stakeholders in project design and implementation. The major stakeholders are: (a) ZPEPC is the beneficiary of the project. (b) SP has been involved in all major sector policy issues and project approval. Both SP and SETC (which has responsibility for power sector regulation) have provided written support to the power market and regulation components of the project. (c) Zhejiang Provincial Government is fully involved in ongoing tariff reform and implementation. The responsible vice-governor has confirmed the Government's support for regulatory system development (d) Communities affected by the project. With regard to the communities affected by the pumped storage component, extensive consultation and community participation has already occurred during the preparatory phases of the project. At the pre-approval phase consultations were carried out as detailed in paras 49 to 53 of Annex 11. In later stages more detailed consultations were carried out in preparing the RAP. For example, based on the preferences of the affected villages and individuals: a land based economic rehabilitation strategy was adopted; the new village site was changed from the east side of the Potangxi stream to the west side for closer proximity to the county town center and a one km length of highway will be constructed to connect the site to the town center; and several irrigation facilities will re-constructed for the host communities. For the transmission component, the substation site of Yuyao was initially to be located in Yangling village, in Zhangting township. However, this village has a very limited amount of cultivated land, and after consultation with local government and residents, a new site at Zhujiamen village, Yuyao township was selected. Participatory and transparent processes will also be employed in the implementation phase in areas such as delivering compensation packages and allocation of housing plots. The resettlers will also be informed of the established grievance procedures. b. Other key stakeholders: The seven investors in the Tongbai Pumped Storage Plant (see Financial) have set up a preparatory committee to make known the views of the investors prior to the incorporation of the limited liability company, at which time a board of directors will be appointed.  Page 18 F: Sustainability and Risks 1. Sustainability: There are no significant environmental impacts that could affect sustainability. Social sustainability is assured by the comprehensive resettlement plans, the "land for land" rehabilitation strategy, and by the excellent record of ZPEPC in resettlement. Financial sustainability is assured by the preinvestment agreements and the affordability of projected tariffs. Institutional sustainability is assured by the "ownership" by ZPEPC of its Sector Reform Strategy and Implementation Plan, and the support for reform coming from central and provincial governments. 2. Critical Risks: (reflecting assumptions in the fourth column of Annex 1) Risk Risk Rating Risk Minimization Measure From Objective to Goal Other generation and transmission expansion N Financial covenants will ensure projects not completed on schedule adequate resource availability for timely completion of scheduled projects Entry of new participants into the market not M Development of mechanisms to achieved because of perceived high risk in advise potential market entrants of immature market and fast changing econorrmic expected growth and investment circumstances. opportunities. Development of transitional arrangements to provide adequate degree of security to commercial lenders (e.g. Contracts for Differences - CfDs. Measures for increased fuel efficiency, such as N Actively support and continue gradual decommissioning of small thermal units dialogue with Government on the and reduction in partial loading continue to be decommissioning of small thermal implemented. units. Power market implementation will reduce partial loading of efficient thermal units. From Outputs to Objective Power sector reform objectives not achieved M Support for power market and due to lack of government commitment. regulatory component obtained from relevant Government departments. SP has designated Zhejiang as one of three province/municipalities to pilot power market implementation. A comprehensive reform implementation plan prepared and agreed with the client. Continued technical assistance.  Page 19 Risk Risk Rating Risk Minimization Measure Efficient operation of power market not M Particular focus on developing achieved, because of excessive ZPEPC market arms-length relationship between power and residual tendency towards entities controlled by ZPEPC and centralized control, or due to lack of the market operator, and progressive understanding and ownership by key personnel. divestiture of ZPEPC generation companies. Adequate hands-on training of ZPEPC personnel in functioning power markets and technical assistance to market participants in early stages of market operation. IIncorrect pricing of output from Tongbai N Tongbai output would be very pumped storage power plant leading to lower attractive even under minimum than expected commercial utilization of project, pricing in line with expected and thereby reduced contribution to peaking substitute peaking units on the and load following capacity. system. When other ancillary services capabilities are factored in, Tongbai would be extremely valuable to the system. From Components to Outputs Schedule and cost overruns due to adverse M Adequate contingency allowances geological conditions. in costing and float in scheduling in potentially critical areas. Schedule and cost overruns due to inadequate M Ensure adequate attention to ZPEPC project management capability, contractor construction management weakness or excessive contractual claims organization responsible for the project. Strict prequalification criteria for civil works (NCB financed by the borrower) Procurement delays. M Prequalification for major E&M supply contracts, Engaging international consultants assisting in preparation of bidding documents and bid evaluation Power market implementation delayed due to: M Identification of all reform (a) inability of Government to finalize key coordination issues and continued policy decisions, (b) slow implementation of policy dialogue with all agencies the necessary technical support systems. during implementation. Close supervision of all technical support systems.  Page 20 Risk Risk Rating Risk Minimization Measure Delays in resettlement implementation due to M (a) advance the preparation of an delays in approval of resettlement budgets, executable resettlement plan with inadequate planning, failure in implementation assistance of experienced or erosicn of compensation value through resettlement specialists; (b) provide I inflation adequate contingency for costing and compensation arrangements to include inflation adjustments; (c) ensure establishment of strong implementation organization, internal and external monitoring and grievance procedures. [Overall Risk Rating M Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N (Negligible or Low Risk) 3. Possible Controversial Aspects: None G: Main Loan Conditions 1. Effectiveness conditions Execution of the subsidiary loan agreement between the Government and ZPEPC, satisfactory to the Bank, would be a condition for loan effectiveness. 2. Agreements to be reached with the Government: The Borrower will onlend the proceeds of the loan to ZPEPC under a subsidiary agreement on the same terms and conditions as the Bank loan, with ZPEPC bearing the foreign exchange risk. 3. Agreements to be Reached with the Beneficiary: Financial Performance (a) ZPEPC shall take all measures necessary to ensure that its internal cash generation is sufficient to maintain a self financing ratio of not less than 30 percent. (b) ZPEPC shall not incur any debt unless a reasonable forecast of the revenue and expenditure shows that the estimated internal cash generation would provide a debt service coverage of no less than 1.5 times at all times; and Financial Reporting, Monitoring, and Aucliting (c) maintain and provide the Bank with semiannual progress reports, with unaudited project accounts to reflect project expenditures and original project cost estimates for the implementation period; (d) furnish to the Bank audited accounts for the project, statements of expenditures, and financial statements within six months of the end of each fiscal year; and require auditors to comply with international auditing practices and provide audit plans for each audit; and (e) by April 30 of each year, furnish to the Bank a rolling long-term financial plan containing projected income statements, fund flow statem-nents, and balance sheets. Power Sector Reform (f) carry out a program of power sector restructuring in accordance with a plan acceptable to the Bank. The agreed plan is detailed in the "'Power Sector Reform Strategy and Implementation Plan in Annex 4".  Page 21 Institutional Building (h) Carry out the management development and training programs as agreed with the Bank. Environment (i) Carry out the Environmental Management Program in a manner satisfactory to the Bank. Resettlement (j) Carry out the resettlement program in accordance with the agreed RAPs. Dam Safety (1) Employ a panel of experts to review design and construction procedures relating to dams. Prepare detailed plans for construction supervision and quality assurance, a plan for instrumentation, an operation and maintenance plan, and an emergency preparedness plan. (m) Cary out periodic inspections of all dams after their completion. H: Readiness for Implementation [X] 1. a) The engineering design documents for the first year's activities are complete and ready for the start of project implementation. [ ] 1. b) Not applicable. [ ] 2. The procurement documents for the first year's activities are complete and ready for the start of project implementation. [X] 3. The Project Implementation Plan has been appraised and found to be realistic and of satisfactory quality. [X] 4. The following items are lacking and are discussed under loan conditions (Section G): 1: Compliance with Bank Policies [X] 1. This project complies with all applicable Bank policies, including, but not limited to: OP 4.01 and OP Enviromnental Consultations with project affected groups, goverment and non- 4.30 Assessment and government social organizations and specialist groups have occurred Involuntary as described in Section E.7. above and paras 49 to 53 of Annex 1 1. Resettlement ElAs, EMPs and RAPs complying with OP 4.01 and 4.30 were forwarded to the Bank Infoshop on 07/18/1999, before appraisal departure on 07/19/1999. Chinese versions of these documents have also been provided to affected villages, and placed in county record centers, which are fully open to the public. OP 4.37 Safety of Dams A panel of experts has been formed to review designs, and will continue to be employed throughout the construction period and start of operations. Prequalification of contractors will be carried out. Plans required by the OP have been or will be carried out at appropriate stages. OP 10.02 J Financial Management Assessment has been carried out (Annex 8). OP 11.02 - Procurement planning fully complies with the OP. Team Leader: Barry Trembath/Ranjit Lamech Sector Directorx4oshihiko Sumi ~- -z---- g - Country Director: Yukon Huang  Page 22 Annex 1: Project Design Summary China: Tongbai Pumped Storage Project Hierarchy of Objectives Key Performzaince Indicators Monitoring and Critical Assumptions Evaluation Sector-related CAS Goal: (Goal to Bank Mission) Reduce infrastructure bottlenecks 1.1 Reduction in Infrastnicture Constraint ZPEPC statistics Continued government to ensure environmentally .d_tcommitment and sustainable development Indicator implementation of overall Improvement in grid reliability - (reduction in economic and sector reform. supply disruptions)1: Continued implementation of necessary rural and urban 1997 2000 2003 2006 infrastructure. Rural Grid 99.2 99.15 99.8 99.8 Urban Grid 99.3 99.15 99.8 99.8 1.2 Environmentally Sustainable Energy ZPEPC statistics Delivery Indicator: Specific fuel consumption in Zhejiang province (in gee/kWh) 1997 2000 2003 2006 Zhejiang 404 396 385 379 Project Development Objective: (Objective to Goal) 1. Improving the operating and 1.1. Investment Efficenc Indicator Utility statistics (ZPEPC Other generation and investment efficiency in generation Percentage of capacity comprising small and ECEPGC) transmission expansion projects by implementing a competitive thermal units (<50 MW): completed on schedule. generation market in Zhejiang 1997 2000 2003 2006 province. 25.8 18.4 11.2 4.7 Entry of new participants in the market not achieved because of perceived high risk in immature 1.2 Market Concentraticn and competitiveness market and fast changing Indicator: economic circumstances. Percentage of generaton capacity controlled by Measures for increased fuel the largest market participant (presently efficiency in addition to reducing ZPEPC): partial loading continue to be 1997 2000 2003 2006 implemented. 57% 45% 35% 20% 2. Increase of peaking capacity 2.1 Load Following Capability Indicator ZPEPC Statistics and improve load following and Improvement in Area Control Error (ACE). power quality in the Zhejiang power 1997 2000 2003 2006 system. 75 78 81 85 Outputs: (Outputs to Objective) 1 The pumped storage power plant 1.1 Key Milestone Indicators: (for details see Site inspection and Correct economic pricing of of 1200 MW in commercial Procurement Annex) commissioning output from Tongbai pumped operation 10/00 Award of equipment supply contract documentation storage power plant leading to 05/02 Award of equipment erection contract expected commercial utilization 07/00 Mobilize LOT I conrTactor Supervision and of project. 03101 Mobilize LOT 2 contractor independent monitoring 09/02 Complete powerhouse excavation reports Power sector reform objectives 02104 Complete upper reservoir works not achieved due to lack of 09/04 First unit in service govemment commitment. 04/06 Fourth (final) unit in service Adequate training and capacity 166 PAH resettled and income restored. building at all levels to ensure understanding and ownership by key personnel 2. Reinforced 500 kV transmission 2.1 Length of transmission lines constructed Supervision and project system in operation (in circuit-km): progress reports Supply Reliability Indicator= [1- (EConsumer not served x number of hours of disruption)/( ZTotal number of consumers x 8760)] 2 ZPEPC will comply with relevant regulations issued by central government authorities in this regard.  Page 23 Hierarchy of Objectives Key Performance Indicators Monitoring and Critical Assumptions Evaluation 1997 2000 2003 2006 . i Site inspection and Zhejiang 1,015 1,758 2,576 commissioning Project 0 0 224 299 documentation 2.2 Transmission transformer capacity added (in MVA): 1997 2000 2003 2006 Zhejiang 325 775 1,150 Project 0 0 75 350 2.3 Communication Lines Added 1997 2000 2003 2006 Zhejiang 325 771 1,106 1,376 Project 0 0 75 350 3.1 Development and 3.1 Progress in refomn implementation will be Implementation of Comprehensive monitored based on 'Power Sector Reform Power Sector Reforms. Strategy and Implementation Plan' (see Annex 4): December 1999: All Thermal Generation stations formed as separate limited liability companies. January 2000: Commence trial market operation December 2001: Market Code formally approved. December 2001: 40 percent of County Power Supply Bureaus formed as Limited Liability Companies December 2003: All county supply companies formed as Limited Liability Companies Project ComponentslSub- Input: (budget for each component) (Components to Outputs) components: 1. Tongbai pumped storage power $405 million 1. Schedule and cost overruns plant due to adverse geological 2. Reinforcement of 500 kV $319 million conditions. transmission system 3. Power market implementation $20 million 2. Schedule and cost overruns and regulatory system due to inadequate project development. Tariff reform, management capability, information system development, contractor weakness or and generation expansion planning. excessive contractual claims. 3. Inadequate procurement planning and management, slow in procurement decisions 4. Power market implementation delayed due to: (a) inability of Government to finalize key policy decisions; (b) slow implementation of adequate technical support systems. 5. Delays in resettlement implementation due to delays in approval of resettlement budgets, inadequate planning, failure in implementation.  Page 24 Annexc 2: Project Description China: Tongbai Pumped Storage Project Introduction I. The Zhejiang Provincial Electric Power Company (ZPEPC) is the main power utility operating in Zhejiang province in the rapidly developing coastal area of Eastern China with a installed generating capacity of over 13,000 MW. The main generation source is coal-fired thermal plant, with hydropower providing less than 10% of the supply. A growing problem is the difficulty in meeting the wide variation between peak and off-peak demand. Most of the thermal plant is suitable only for operation at more-or- less constant load and the more flexible hydro plant is insufficient to cover the load variation. The gap between on and off-peak demand is forecast to exceed 4,000 MW by 2005. In summary, a substantial amount of additional peak-load type generation plant is required. 2. The project consists of three components: (a) Tongbai Pumped Storage Power Plant, with an installed capacity of 1200 MW. (b) A Transmission and distribution component consisting of some 400 km of 500 kV associated transmission lines and substations, distribution management systems for Hangzhou and rNingbo municipalities, and province wide customer service centers. (c) A Power Sector Restructuring Component. 3. This annex describes the two physical components of the project. The power sector restructuring component is fully described in Annex 4. The Tongbai Pumped Storage Power Plaint 4. The first comprehensive study was completed with the issue of a pre-feasibility study report in June 1994. This was followed by a feasibilily study report in October 1996. The project was been subsequently brought to the preliminary design level in 1998. 5. This project component exploits an existing upper reservoir built in the 1960s and presently part of an 8 MW hydro power plant. A new lower reservoir is to be built, together with an underground powerhouse. Both reservoirs are small with surface areas of 78 ha (upper) and 48 ha (lower) and are sited on small streams. The reservoirs will act as transfer ponds with sufficient storage (around 11 million m3) for a daily operating cycle - the -per reservoir is typically full at daybreak and is used to provide water for generation during the day, particularly at the early evening peak demand period. By late evening, as electricity demand drops, the lower reservoir is now nearly full (the upper empty) and the pattern is reversed with water transferred during the riight by pumping from the lower to the upper reservoir. The site is about 215 km (straight-line distance) from Hangzhou, the provincial capital and has excellent access. There is more than adequate knowledge on site conditions (notably geology) due to the combination of the construction experience from the existing hydro project plus extensive site investigations. The underground powerhouse and waterways are largely located within a strong, granite rock strata. The existing power plant will be operated for a time during the construction period but then abandoned.  Page 25 6. The main features of the pumped storage plant are (a table of key statistics is attached): (a) Upper Reservoir (Existing) is located on a small stream (the Tongbai), with a drainage area of 6.7 km2, at the edge of a mountainous plateau at an elevation of 400m. The plateau drops steeply to a plain at an elevation of around 100m. This 300m drop provides the physical rationale for the plant. The reservoir is fed by runoff diverted from several adjacent streams, the total drainage area intercepted is 61 km2. The existing reservoir levels will be unchanged and the only significant physical modification required in the reservoir area is the addition of a new intake/outlet structure. The dam embankment will also be strengthened to ensure its long-term stability and safety. The plateau is accessible from the well-developed plain below by a new so-called "scenic tourist" road about 6 km long. This road was recently built by the local authorities and is intended to open up the plateau to tourism - the rim of the plateau provides magnificent views. (b) Lower Reservoir. The Baizhang river flows along the base of the plateau and will be dammed to form the lower reservoir. The upstream 15.5 km2 of the basin is at present diverted into the upper reservoir; the diversion will continue in effect and the remaining drainage area feeding the lower reservoir is only 6 km2. The dam is a concrete faced rockfill embankment some 420 m long with a maximum height of 68 m. Flow is discharged from the reservoir via a low level release tunnel (which allows the reservoir to be emptied if necessary) and an ungated spillway. Design floods are low (a function of the small river basin) with a maximum of 500 m3/s. (c) Power Facilities. The powerhouse and water conveyance system are located underground (as is the small existing powerhouse which will be abandoned upon project completion). The one major surface feature is the switchyard. The upper reservoir intake/outlet structure incorporates twin openings leading to inclined pressure shafts 9.0 m diameter, subsequently bifurcating into individual 5.5 m diameter steel-lined penstock tunnels. The machine hall cavern houses 4x300 MW reversible pump/turbine units and is about 170m long by 24m high and 54m high. The transformers are located in an adjacent transformer hall. (d) Operating Considerations. The units will operate at a rated head of 239 m. Maximum plant discharge is 580 m3/s. The reservoirs are sized, i.e. have sufficient storage, to allow operation at full output of four to five hours a day. The average annual generation is estimated at 1560 GWh. a plant factor of 17.8 %. With an overall efficiency of 75%, pumping energy required is some 2080 GWI/yr. The natural inflow from the various small river basins averages about 1.85 m3/s (58 mcm/yr) more than enough to cover maximum evaporation and leakage losses. Reservoir storage is ample to accommodate the small volumes of incoming sediment. The two reservoirs feature a considerable range of draw down (maxima of 20 and 29 m in the upper and lower reservoirs respectively) most of which will be used on a daily basis. The Transmission and Distribution Component 7. The existing grid is largely based on 220 kV transmission together with a limited coverage of 500 kV lines (1200 km and 2750 MVA of capacity) in the Hangzhou area linking it to the major thermal power plants on the coast to the East and to Shanghai and Anhui province in the North. An expanded 500 kV transmission grid is now required to handle the growth in demand. The facilities included in this component are: (a) erection of twin 500 kV transmission lines (1 10 km long) connecting the Tongbai plant to the 500 kV grid at Zhuji and the construction of a 500 kV substation at Zhuji;  Page 26 (b) construction of two 500 kV substations at Xiaoshan and Yongxi, each with a capacity of 750 MVA; (c) expansion of existing substations at Ningbo and Wenzhou by 1,000 MVA each and the erection of a 500 kV transmission line, 275 km long, between the two substations; (d) erection of three short 500 kV double-circuit transmission lines connecting substations at Zhuji, Yongxi and Xiaoshan to existing transmission lines; and (e) supply and installation of associated telecommunication and dispatch automation equipment. Distribution Management Systems 8. To improve reliability and quality of energy, ZPEPC will implement distribution management systems in Hangzhou and Ningbo. The DMV[Ss will be based on safe, reliable and open platforms that provide various advanced services and a powerful functional environment for application implementation, allowing for operation of several independent application subsystems on the platform. A distributed, open, modular, expandable, integrated automation system will be adopted providing basic services such as hardware technology and core operation system, and other services such as database system, information transfer, man machine interface, real-time environment application, geographic environment application and interface with other subsystems. 9. The main functions on the platform will include: (a) Distribution Automation (DA). providing for real-time supervisory/control and data acquisition for the distribution network. (b) Geographic Information Systerrm (GIS), through GIS technology, real-time control is integrated with off-line application, and a layered database that combines spatial concept (geographical land-base information) with basic information (network data and customer data). The database will provide the ability to query and manage basic information, and provide an efficient network model with geographical background for power system operation. It will also provide a database platformn to support other applications such as SCADA, TCM and Customer Service Management System. (c) Trouble Call Management (TCM) containing the functional modules of customer trouble call management, fault diagnosis, fauLlt location, and outage restoration. It is used to manage the process from distribution outage to restoration. (d) SCADA system of distribution and relevant district grids. The SCADA master stations shall satisfy monitoring and controlling requirements of distribution and related district power grid of Hangzhou and Ningbo. The system functions shall be expandable according to practical demands. The Man Machine stations of SCADA shall have two types: one for distribution and the other for the related district power grid. (e) Distribution Network Analysis Software. The following application software suitable for city distribution analysis will also be procured: distribution network modelling and topology, load modelling and calibration, distribution load flow, network optimisation and reconfiguration. (f) Interface with legacy subsystem. such as MIS  Page 27 Customer Service Centers 10. Customer Service Centers (CSCs) will be established in ZPEPC headquarters and the 11 municipal power bureaus to provide customers with a one-stop information service. The CSC is a centralized telephone/information access center which will handle all telephone calls, faxes and intemet inquiries from customers in the respective service areas of the municipal power bureaus. Currently customers need to search for the appropriate telephone number of local business offices (more than ten offices under one municipal bureau) to make inquiries. Even when this office is reached, service can be very slow. When the CSCs are established, a single telephone number will be used throughout the province and customers will be able to call this well-known number for any kinds of contact to the power utility. The CSC with skilled operators and modem technology will be able to respond to customers' inquiries, requests, applications and complaints through phone calls, faxes and emails in an appropriate and timely manner. The CSC will be supported by a modem computerized customer information system and phone call management system. ZPEPC has already developed an Electricity Sales Business Information Management System and the pilot system has been implemented in Shaoxing. This system will be rolled out to the whole province in 2000 after which all local business offices will have access to data through the ZPEPC intranet. The CSC will be built on this foundation. 11. The CSC component will include: (a) installation of information system hardware and software to be integrated to ZPEPC intranet; (b) installation of modem digital telephone control system including automatic call distribution, auto dial, auto transfer, and voice message, and development of supporting system software to be integrated with the existing Electricity Sales Business Information Management System; and (c) development of a customer business analysis system and an application processing system Tongbai Pumped Storage Power Plant Table of Key Statistics Hydrology: total catchment area 67 km2 Natural runoff 1.7 m3/s (upper), 0.14 m3/s (lower) Maximum design floods 208 m3/s (upper), 496 m3/s (lower) Reservoir levels 396-376 m (upper), 141-110 m (lower) Reservoir surface area at FSL 79 ha (upper), 48 ha (lower) Live storage 10.6 million m3 (both) Rated plant capacity 4x300 = 1200 MW Rated plant discharge 4x145 = 580 m3/s Power waterway 2x9 m dia inclined shafts and penstock tunnels plus 5.5 m dia individual steel-lined unit penstocks. Typical length 940 m. 4x7 m dia tailrace tunnels 4x7 m dia 330 m long tailrace tunnels Powerhouse, machine hall Underground, 172x24x54 m (LxWxH) Transformer hall Underground, 163x18x29 m (LxWxH) Lower dam Concrete-faced rockfill, 424 mx68 m (Lxmax.ht) Spillway Ungated chute, 21.5 m wide, 496 m3/s Diversion and outlet tunnel 4.8 m dia 550 m long Unit head range 230 to 289 m Turbine/Pump 239 m rated head (turbine), 250 rpm, 5.8 m dia runner Motor/Generator 333 MVA at 0.9PF and 50 Hz (generator) Transformers 4x360 MVA, 500 kV 3-phase Construction quantities Excavation: 2.1 million m3 (surface), 0.7 million m3 (underground) Embankment fill: 2.0 million m3 Concrete: 230,000 m3 Steel structures: 4300 tonnes  Page 28 Annex 3: Estimated Project Costs China: Tongbai Pumped Storage Project Local Foreign Total Project Cost By Component US$ million Tongbai Pumped Storage Plant 165.19 189.19 354.38 ,Tnsmission and Distribution 202.75 79.53 282.28 power Market and Regulatory System 0.00 10.00 10.00 367.94 278.72 646.66 Total Baseline Cost Physical Contingencies 31.81 13.29 45.10 Price Contingencies 27.97 24.79 52.76 Total Project Costs 427.72 316.80 744.52 Interest during construction 72.09 84.31 156.40 Front-end fee 3.20 3.20 Total Financing Required 499.81 404.31 904.12 Local Foreign Total Project Cost by Category - US$ million ioods 148.63 296.49 445.12 mlorks 186.93 186.93 services Engineering, Procurement and Const. Mngmnt. 44.96 7.15 52.11 Owner's Administration 12.84 12.84 Studies and Training 0.60 13.16 13.76 Environment and Resettlement 33.76 33.76 Total Project Costs 427.72 316.80 744.52 Interest during construction 72.09 84.31 156.40 F-ront-end fee 3.20 3.20 Total Financing Required 499.81 404.31 904.12  Page 29 Annex 4: Power Sector Reform Strategy & Implementation Plan China: Tongbai Pumped Storage Project A. Introduction 1. Over the three-year period from 1999-2001, the power sector in Zhejiang will be very substantially restructured and institutionally transformed. These reforms cover: reorganization of generation, distribution and transmission operations; implementation of a competitive generation market; development of regulatory processes and institutions; and improved management systems within ZPEPC. While institutional reforms have been an integral component of the Bank's lending in Zhejiang, work related to sector reform was first initiated as part of the Zhejiang Power Development Project approved in February 1995.1 The Zhejiang Power Development Project, began the evaluation and development of a comprehensive power sector reform action plan. The objective of this plan was to institutionalize incentives for commercial sector operations and introduce competition where possible. In addition, the plan included the a review of the financial and accounting systems and the development of a new Financial Management Information System (FMIS). Detailed design and implementation is underway in all areas. 2. The proposed Tongbai Pumped Storage Project advances this work and introduces new reform elements to ensure a comprehensive implementation effort. In recognition of the work that has already been completed and the reforms planned, the State Development and Planning Commission (SDPC) and the State Power Corporation (SPC) have designated Zhejiang province to be one of the three provinces to pilot power sector reform. Zhejiang has also been specifically designated as the province to pilot power market introduction The lessons from Zhejiang will therefore influence the wider adoption of comprehensive power sector reforms in China. This document has been prepared to provide an overview of the reform context in Zhejiang, and outline the different reforms that will be implemented as part of the Tongbai Pumped Storage Project. 3. The main components of the reform program include: (a) Introduction of generator competition by implementing a single buyer market structure with a mandatory pool - as a first step towards a more competitive wholesale power market. A market code and associated settlement systems will be implemented to manage the pool transactions. (b) Asset restructuring and corporatization of generation - all generators will be formed as independent companies, separated from the Single Buyer. Corporate governance reforms will facilitate the separation of generation ownership and management, from that of transmission and distribution (c) Consolidation of decentralized and fragmented distribution operations in Zhejiang province and corporatization of Power Supply Bureaus. (d) Development and implementation of a regulatory framework of rules, procedures and institutions to oversee the generation market and regulate the sector as a whole. (e) Further support for implementation of new systems for Enterprise Resource Planning (ERP) customer services and office automation in ZPEPC. There were two previous projects whose impacts, while substantial, focused on capacity building in least cost system expansion planning, tariff design, technical operator training, etc.  Page 30 (f) Training and capacity building for the operating entities and the staff of the proposed regulatory body in generation planning and retail tariff design. B. Reform Drivers 4. Power sector reform in Zhejiang in particular, and China in general, is being driven by the following factors: (a) Inefficiencies in Generation Plant Utilization. Generation plant is being operated (i.e. dispatched) in a manner that is economically inefficient. The prevailing practice in China has been to assure plants a certain minimum number of operating hours and compensate them on the basis oi a one-part tariff. Most coal-fired thermal units are therefore assured a fixed number of operating hours, irrespective of their marginal operating cost. Although ZPEIPC made an effort to operate a system which facilitated economic dispatch - thlis has not been entirely successful owing to the underlying generator contracts guaranteeing a specific number of hours. (b) Sub-Optimal Generation Investment. Investment in new generation is not being made efficiently with adequate consideration for economies of scale. The Government's "new-plant, new-price" policy, which was successful in attracting substantial new investment in the generation sector, was less successful in ensuring efficient investment. There are substantial amounts ofjoint venture generation investments which have not fully exploited scale economies, nor led to the selection of the most suitable generation technologies. (c) Decentralized and Fragmented Distribution Entities. Distribution and consumer supply functions are undertaken by decentralized power supply bureaus at many levels - municipal, county, township, and village. While this decentralization has helped to bring in consumer contributions to cover connection costs and expand access, the operating and management efficiency of these local companies is generally considered to be sub-optimal - with high technical losses stemming from under-designed systems often constructed with inefficient equipments In addition the consumer tariff varies widely, often in excess of long-ran marginal costs, as local governments use the consumer tariff as a fiscal instrument to collect various levies - while this practice has been recently banned by the central govemment, the ban has not yet been implemented pending central government approval of new tariff structures. (d) Government Administrative Refrorm Initiatives. The Government of China has begun a wide-ranging administrative reform of government ministries and state- owned enterprise to achieve: (i) a clear separation of the government's regulatory and policy functions from its asset management functions; (ii) the management and operation of state-owned enterprises as truly commercial entities. Changes are occurring at all levels of Government in China. In March 1998, the former Ministry of Electric Power was abolished and its regulatory responsibilities transferred to the State Economic and Trade Commission (SETC) at the National level. In parallel, the Government created an independent asset holding entity (i.e. the State Power Corporation) to own central goverinment investment in the power sector, and not participate in power sector regulation. The long anticipated separation of the Power Bureaus from the Provincial Power Companies is now expected to occur in 1999, 2 Decentralized distribution systems often have low-voltage lines (e.g. 400 kV and 220 kV) strung over extremely long distances exacerbating line losses. Transformers are generally under-sized and often constructed with material that lead to high core-losses.  Page 31 thereby creating the institutional basis for coordinated central and provincial level regulatory oversight of the power sector. C. Market Structure Reforms 5. ZPEPC will implement a generation market with an incentive structure which will facilitate: (i) competition amongst generators for dispatch leading to the efficient use of available generation capacity; (ii) the efficient procurement of new generation capacity; and, (iii) the gradual and smooth transition to wholesale competition. 6. To achieve the above, ZPEPC worked with a consortium of consultants led by Pacific Power International (PPI) to develop a power market structure that would be feasible for implementation in Zhejiang. The approach developed is based on creating a Single Buyer with a mandatory pool market wherein generators must submit bids in order to be dispatched. The generator market would transition to a structure wherein distributors would be gradually allowed to contract directly with generators (i.e. wholesale competition). This staged evolution from a market with generator competition managed by a Single Buyer operating a mandatory balancing pool, to wholesale competition in subsequent stages is an innovative way to gradually introduce competition in the power sector. More importantly, this staged process allows participants to acquire commercial skills and capabilities to operate in an increasingly competitive environment. 7. The Single Buyer in Zhejiang will be required to participate in the East China Regional Market, wherein the East China Electric Power Group will manage a bulletin board system (BBS) for longer-term bilateral trades and a Price Based Energy Broker for shorter term spot trades3 8. The main structural and operating features of this market are: (a) ZPEPC will be restructured into a transmission and distribution company - hereafter referred to as the Zhejiang Provincial Grid Company (ZPGC). Generation will be separated into companies independent from ZPGC. Initially hydro is expected to be closely affiliated to ZPGC, in order to optimize the resource use and balance other water management considerations.4 (b) ZPGC will have a unit to perform the functions of the Single Buyer (SB) and the Market System Operator (MSO). The SB will also undertake the capacity planning for the system and coordinate demand forecasting with the distribution entities. The MSO will be responsible for unit dispatch and managing the settlement operations. (c) The Single Buyer will be the unit that signs the initial contracts (i.e. vesting contracts for differences) with all the generators. (d) All the generators will be given initial vesting contracts for differences (CfDs) for a given level of demand. It is intended that the initial CfDs will provide the generators a base level of revenue security - perhaps close to their current revenues. Over time this coverage is expected to be reduced. (e) The initial vesting contract for differences will be constructed in a manner that would establish certain contract quantities and contract prices based on a forecast view of the expected pool price., that would deliver a satisfactory financial outcome for each 3 This regional power market structure is being implemented as part of the East China (Jiangsu) Power Transmission Project, approved in March 1998. 4 It is expected that the hydro plants will be operated as "price-takers" to prevent them from being used opportunistically in the market to set unduly high prices.  Page 32 generator. A decision has been made to provide all generators participating in the market with contract coverage for 85% of their expected revenue requirements i.e. 85% of the revenue obtained from prevailing agreements based on 5,500 operating hours. In other words, generators would be expected to compete for around 15% of their required revenues in the electricity spot market. (f) The incentives established by the mandatory pool and the CfD would include: economic dispatch based on generator bid prices; generators bidding with a view to exceed their contract quantities; and generators bidding close to their marginal cost. (g) The skills that the mandatory pool with CfDs will help establish include: Generator skills in understanding their costs, preparing bids and negotiating contracts; and power market management skills within the MSO (h) The distributors will be expected to cover a minimum level of demand through the SB to correspond to the volumes contracted for under the CfDs. Distributors will be allowed to use their own embedded generation to meet local load beyond the levels contracted with the SB.s (i) New generation will be obtained through competitive bidding conducted by the Single Buyer. Consistent with the objective of gradually reducing the contract coverage given to generators, the competitive bidding will be done in a manner which balances offered price anid contractual coverage needed by new generators. 9. ZPEPC is working on the followingr detailed market implementation tasks: (a) Market Code. The Market Code is the central document that will govern the operation of the competitive generator market. The Code will be administered by the Market System Operator (MSO). The draft Market Code was completed by PPI in May 1999. The Market Code has been approved for implementation by the provincial government and SETC. Key components of the Market Code covering aspects such as bidding, scheduling, dispatch and settlement have been utilized for developing the trading and settlement system. A simulation exercise has been started to test the Market Code. A revised version of the Code is being prepared in Chinese and the full package is expected to be sent for formal review by central government agencies in September 1999. The aspects covered by the Code include: * System operation principles and rules * Market rules * Mechanism to determine market prices * Ancillary service pricing mechanisms * Network service pricing mechanism * Principles of transmission access * System security rules * Metering standards and codes * Rules on CfD basic terms 5 Most local power supply bureaus own and operate generation plant to meet a portion of their demand. Some of this generation, particularly thermal, is generally high cost and are not expected to be able to compete with larger grid generators in the market. By setting a limit on how much distributors can utilize embedded generation to meet native load, it is expected that these potentially non-competitive embedded generators will gradually phased out and retired.  P 33 (b) Market Trading and Aeiieme,t e market settlement system is required to receive generator bids, eorssr J-atc' schedules and process settlements. ZPEPC evaluated the marklt se.-n-Jenntne.1 syste.m that was being used in the New South Wales market in Australia (i.e ETLEX A customized version of this system was being offered by the PPI/Transgric, consort1urn fIr use in Zhejiang. ZPEPC's detailed evaluation indicated tha. 'ie systemn was constructed on a now obsolete platform, and would also recju`re ext.-nsr custornization of the screens to make it usable by plant and systerm cperatacrs Whi o nly read Chinese. It was therefore decided to deve'lop the softwa-c in Chi.na wrth the guidance of PPI/Transgrid. Nanjing Automation Research lrsti. ie ( ARI) has been contracted to develop the market settlement system softreare. a development of the market trading and settlement system is proceeQdin. a. k dcqespite the ambitious schedule. Three of the main modules are being tested through mnarket simulation exercises. These are simulation exercises are intderd tcst bol'h the computer software and the suitability of the Market Code-. es'3-yst enr tests will be extended to actually schedule and dispatch generators on the b obc from October 1999 onwards. During these system tests cash setflemel t ;VoeOad contitnue based on the existing contracts. The system is expected to be rd -y fbi- r e tri hal operations in January 2000 which would involve cash settleinent bsdn actual dispatch and the CfDs. Market Implementation - Key D atas (i) Central and Provincial Governrnerjt - 01 .Markc: September 1999 Code and Clearance for Market an .ra (ii) Market simulations - To test ger biGi a bd.i October-November procedures; settlement systems; t g,-n- gera;rn plant and 1999 MSO staff; simulation of dispatch' see 3., .e physical market would clear; etc. (iii) Completion of all preparatory wvor1 t_o i ze the December 1999 market: settlement systems; market - I , tation training; initial CfDs; generator t4Zmc-fit arket System Operator and Single Buyer vi n, -, (iv) Commence and conduct trial oper. icn market January 2000 onwards (v) Evaluation of Market by SETC and WStza ,.Pwer January/February 2001 (vi) Modification and Finalization oC oardV. (o e February/March 2001 D. Industry and a'' ixwcturing in Zhejiang 10. Extensive asset restructuring 5an o separation into different corporations will be necessary to create an industry structure tha- iv consisteat with the market structure being implemented. In addition, the govemnrtn is ad- mciCng a restructuring program to consolidate the decentralized distribution operations intc. w'- 1managed commercial enterprises. The restructuring and separation of generation 4-&m the downstream. transmission and distribution operations will be done in thw , hort-enA (i.e. by 2000). The reorganization of distribution operations will be done over '`n''' cpGriiQrie of time.  Page 34 The Present Situation 11. The power system in Zhejiang is the third largest in China, in terms of installed capacity and load, which at the end of 1997 reached 12,600 MW and 48.5 TWh. The main features of the structure are described below and shown in Figure 1. (a) Zhejiang Provincial Electric Power Corporation (ZPEPC) is the main power enterprise in the province. ZPEPC is a vertically integrated company, which owns and operates the provincial transmission network6 A large part of the generation and a lesser share of distribution operations/enterprises in the sector, are also owned and controlled by ZPEPC. (b) ZPEPC is wholly owned by the East China Electric Power Group Corporation (ECEPGC) - the regional power group corporation in East China. ECEPGC is in turn wholly owned by the State Power Corporation. (This ownership structure is under review and is likely to be changed. The most probable outcome is that ECEPGC becoming a department of State Power, and State Power owning ZPEPC directly). (c) There are multiple owners/investors of the installed generation in Zhejiang. Apart from ZPEPC, other players with substantive ownership stakes are: (i) Zhejiang Provincial Electric Power Development Corporation (ZPEPDC) - the investment arm of the Provincial Government and recipient of the 2-fen/kWh power surcharge; (ii) the Huaneng Group - a leading IPP investor which is listed in New York; (iii) the Zhejiang Southeast Power Cornpany listed in the Shanghai (B market) and London. (d) Of the installed capacity of 12,600 MW, ZPEPC directly dispatches 7,018 MW. ZPEPC has a investment stake iin much of the generation it currently dispatches. A further 4,604 MW is embedded generation i.e. it is located in the medium-voltage distribution network. These ernbedded generators are dispatched by the local prefectural/municipal/county dispatchers. (e) A large share of the embedded generators are inefficient coal-fired and oil/diesel units. The rest is mainly run-of.-river hydro plant. The embedded thermal plants are currently not permitted to generate during off-peak hours. To deal with the stranded cost problem of these inefficienrt embedded thermal generators in a competitive generation market, the intention is to limit their absolute energy output and restrict their operation to peak hours. Capacity % of Total Generation % of Total (MW) Capacity (GWh) Generation Hydro owned and dispatched by 960 7.7% 1,992 4.1% ECEPGC ZPEPC owned/managed and dispatched 7,018 55.8% 35,664 73.4% Local embedded generation (>6 MW) 2,352 18.6% 8,435 17.4% Local embedded generation (<6 MW) 2,252 17.9% 2,485 5.1% 12,582 48,576 (f) Qishan Nuclear Plant 1 is largely owned and managed by China Nuclear Energy Corporation. ZPEPC has a small share (around 10%) in Qishan Nuclear. There are 6 Some of the 500 kV lines in the Zhejiang province are owned by the East China Electric Power Group Corporation. While there are clear asset ownership boundaries, further work is needed in clearly delineate the provincial and regional transmission networks from the perspective of provincial and regional market operations.  Page 35 two other nuclear power stations under construction with similar ownership arrangements Qinshan 2 with Chinese technology and Qinshan 3 with Canadian technology. (g) There are two main levels of distribution enterprises in Zhejiang - the municipal level and the county level. There are 11 municipal level power supply bureaus (MPSBs), 10 are wholly owned and managed by ZPEPC and have no independent legal status. The eleventh is owned by the Zoushan municipal government and is an independent legal entity. (h) There are 66 county-level power companies. The county-level power companies serve the retail consumer, sometimes directly or in some instances through township and village level entities. In addition to operating the local distribution, most county power companies have small hydro and thermal plants (see discussion on embedded generation in (e) above). The ownership and management of the county enterprises varies as shown in figure 1. The fragmentation below the county level entity is substantial- there are 1,674 township distribution units, and about 40,000 village level distribution units. The township and village level distribution units are generally collectively owned, with operations franchised to private operators or done by the collectives themselves. (i) Many of the decentralized distribution units are considered to be inefficiently operated, both technically and in staffing terms. Technical losses are high owing to poor design practice - low-voltage lines are strung over long distances and transformers are under-designed. In many cases, the transformers are locally manufactured with sub-standard materials leading to high core losses. These distribution units are also grossly overstaffed, often with inadequately trained personnel.  Page 36 Figure 1: The Power Sector Structure in Zhejiang- December 1998 ZPEPC I - - - - _ - - - - - - - - - - Generation ZPEPC ODwned and Managed I~ ~ l East China Power Group | l Generation I Transmission IIPPs I-I Distribution l Municipal Power Supply l l Bureaus (MPSBs) (10 ZPEPC Owned MSBs) Distribution I Distribution l Distribution 1 Independent MPSB l 26 County Power Supply 38 County PSBs (with 2 County PSBs) Bureaus (CPSBs) Local Govt. Owned & Managed I (ZPEPC Owned/Managed) Corsumers Future Plans 12. The plan for asset and enterprise restructuring are as follows (See Figure 2): (a) Thermal generation will be completely separated from ZPEPC. A separate entity, called the Zhejiang Provincial G:rid Company (ZPGC) will be formed to hold the transmission and distribution assets, as well as perform the functions of the Single Buyer and Market System Operator (MSO). (b) Generation Restructuring: (i) All thermal grid generation stations that will participate in the provincial power market are being separated and corporatized as independent limited liability corporations. Most of the thermal generation stations have already been corporatized - as of now only Zhenhai and Banshan remain to be corporatized.. The formation of all thermal generation stations as LLCs is expected to be completed by the end of 1999. Table 2. Lists the different generation stations and their ownership structure. (ii) The hydro owned by ZP]EPC (i.e. Jinshuitan, and Wuxijiang) will remain closely linked to ZPGC. Other stations (e.g. Xinanjiang and Fuchunjiang) which are owned ECEPGC and will remain as such. (iii) Qinshan Nuclear will remain under existing ownership arrangements i.e. with ZPEPC holding a minority stake.  Page 37 Figure 2: The Power Sector Structure in Zhejiang - December 2000 Zhejiang Provincial Grid Company (ZPGC) . ~~~~~~~~~East China Power Group Generation formerly owned and Generation managed directly by ZPEPC Market System Operator (see Figure 3) ___ Single Buyer Transmission Distribution To be gradually _ 10 Municipal Power Supply brought under ZPGC Bureaus ( MPSBs ) management and control Distribution DiopStrButio Distribution 1 Independent MPSB Formed as Limited Liability Cos Formed as Limited Liability Cos. Consumers l (c) Distribution Reform and Restructuring (1999-2000): (i) All county Power Supply Bureaus CPSBs will be formed as limited liability corporations (LLCs). In 1999, five CPSBs wholly owned and managed by ZPEPC will be formed as LLCs in year 2000. Forty of the remaining CPSBs will be formed as LLCs. By 2001 all remaining CPSBs will be formed as LLCs. (ii) ZPGC will take over the management of the independent CPSBs, and increase their ownership stake in these CPSBs by investing in them. In the three year period 1999-2001, ZPGC will invest around 1.4 billion USD in upgrading distribution systems at the municipal and county level. (iii) Complete a process of staff certification to determine the appropriate staffing levels in the CPSBs and the township/village level entities. Currently, there are over 40,000 staff employed by these independent CPSBs and township/village entities. Technical assistance will be provided under the project to evaluate and develop a strategy for restructuring distribution operations in Zhejiang.  Page 38 Table 2: Thermal Generation Corporatization Plan (Completion by end-1999) Station/Company Name Capacity ZPEPC Stake Other Investors Wenzhou I 250 MW Nil ZPEPDC 66.9% WPDC 33.1 Wenzhou CCGT 300 MW Nil ZPEPDC47% WPDC 53% Wenshou II 600 M W Nil Sithe 40% ZPEPDC 30% VWPDC 30% Changxing Huaneng 250 MVV Nil Huaneng 100% Jiaxing 600 MW 30% ZPEPDC 70% Dongnan Power Co. 25% Listed shares 34% (Zhejiang South East Co.) 1,410 MW ZPEPDC 41% - Taizhou 250 M1W - Shaoshan Beilungang Ii,200 M W1, 70% ZPEPDC32% Beilungang II 1,800 M W 36% ZPEPDC 34% ECEPGC 30% 7.henhai * ~~~~---~------------------- ....................__._ - Units 1 and 2 250 MW Nil Huaneng 100% - Units 3 and 4 400 MW 75% ZPEPDC 25% - Units 5 and 6 400 MW 39.12% ZPEPDC 60.88% 13anshan * - Units 2 and 3 oo0MW 100% - Unit 4 125 MW 100% - Unit 5 125 MW Nil ZPEPDC 50% IHangzhou City 50% The restructung of Zhenhai and Banshan to form limited liability corporations is a more complex process owing to different ownership structures for individual units and difficulties in agreeing on valuations with investors. Corporate Governance of Generation and Minimizing Generator Market Power 13. A clearly recognized problem of the restructuring strategy is that ZPEPC continues to maintain a stake in generation, as well as operates the market through ZPGC. There are two concerns: (i) in scheduling dispatch, ZPGC could favor generation in which its parent ZPEPC has an ownership interest; (ii) the generation firmrs in which ZPEPC (and also ZPEPDC) have an ownership interest, although separate, could conceivably collude in their price bidding strategies, leading to prices well in excess of marginal costs. Given the constraints to divesting ZPEPC and ZPEPDC of their substantive ownership stakes in generation over the medium-term, one of the proposed approaches being considered to minimize the potential for collusion is shown in Figure 3 and described below. Indications are that the Government may prescribe guidelines for the complete ownership separation of generation from the transmission and market operator, obviating the need to create an asset holding entity. (a) Form ZPEPC, principally as an asset holding entity, holding investments in independent generation and the Grid Company. The core ZPGC (transmission and distribution) entity will be formed with a strong and independent management group. (b) Ensure that the Market System Operator and Single Buyer functions operate as ring- fenced entities within ZPGC.  Page 39 (c) Create all grid generation stations as separate corporations and not permit any asset mergers until the relative market share of each generator during critical peak periods, and their market power potential can be ascertained.7 Mergers would be allowed only after there is adequate experience from market operation to allow the regulator to informed decisions. Figure 3: Generation Asset Holding and Corporate Governance Structure State Power CorporatIon Provinclal/Local Govemment Private Equity Public Shareholders Investment Companies Investors NYSE and London A & B Shareholders Zhejiang Provincial Electric Power Company (ZPEPC) Multiple Generation Compfnies 100% ownership *l r Jointventure l Indepem dent Powe.r PublclyListedT Genro .Companies Producers PP) GtigCos. Zhejiang Provincial Grid Company (ZPGC) (d) Disallow the merger of ZPEPC and ZPEPDC ownership interests, representing central government and provincial government ownership stakes respectively. This merger was once under consideration, but this idea has now been dropped to create more diverse ownership in the generation sector. (e) Each generation station will have a separate board of directors with the composition adjusted to minimize the potential for collusive behavior. Although it is recognized that this alone cannot prevent collusion, it is a step in the right direction towards independent generator operation. E. Power Sector Regulation in Zhejiang 14. To supplement the on-going efforts to implement a power market and corporatize the power enterprises in Zhejiang, it is necessary to establish an adequate regulatory framework to oversee the market and the power enterprises. The effort to create a provincial level regulatory system in Zhejiang, builds on earlier policy work done by the World Bank. In 1995-96, the World Bank and the Ministry of Electric Power jointly prepared a report on regulating the Chinese power sector.' This work led to: (i) a definition of the basic principles of power sector 7 This task is expected to be done by the Zhejiang Regulatory Agency. 'China: Power Sector Regulation in a Socialist Market Economy, World Bank Discussion Paper No. 361, March 1997.  Page 40 regulation; (ii) an evaluation of possible institutional structures for conducting regulation in China; and (iii) a definition of the scope of regulatory tasks required at the national and provincial level. 15. Recent Government administrative reforms at the Central government level, such as the abolition of the former Ministry of Electric Power and the transfer of its regulatory responsibilities to SETC, provide a basis to begin defining and implementing formal regulatory processes. The institutional form and functional responsibilities of the Central level regulatory agency within SETC still need to be clearly defined. This makes key decisions on allocating regulatory responsibilities between the Central and Provincial level difficult to coordinate. Despite these drawbacks, Zhejiang has a considerable amount of "tacit" flexibility in developing a regulatory system for implementation, by virtue of being an SDPC-designated pilot province to undertake comprehensive power sector reforms. As a first step, there is general agreement between the provincial and national level regulatory entities9 to proceed with the development of a framework of regulations and procedures to enable the trial operation of the generation market. The current approach is to proceed with the assumption that a (power) department within the Provincial Economic and Planning Commission will be the regulator. This department will coordinate its decisions with other central and provincial government entities who may continue to hold specific decision-making responsibilities. 16. A team from National Economic Research Associates (NERA, UK) have been hiredo to assist in developing the basic design of the regulatory system that may be implemented in Zhejiang. The recommendations of this effort were discussed at a workshop in Hangzhou on July 6, 1999. Participants at this workshop, including representatives from SETC, State Power, ECEPGC, Zhejiang PETC, Zhejiang Pricing -Bureau and the State Organization Department. At this workshop ZPEPC presented the options for implementing the regulatory framework. The following were the main conclusions: (a) The option of establishing the regulatory agency as a separate entity funded by license fees was preferred to creating the agency as part of the Provincial Economic and Trade Commission which would require a budget allocation. (b) A provincial level Law which specified the market structure, form of the regulatory agency and its functions would be necessary. In order for such a provincial Law to be drafted and submitted to the Provincial People's Congress an amendment to the existing national Electricity Law would be required. However, it would be possible to present the Law for consideration by the Provincial Congress on the basis of directive from the State Council. (c) The draft of the provincial Law would be completed and submitted to the relevant provincial and central governmenrt agencies for review in November 1999. 17. A final report with a complete packag,z comprising the draft Law and licenses will be submitted in September. 18. Follow-up technical assistance support to implement the regulatory framework and support training of regulatory staff has been discussed. ZPEPC will prepare a list of regulations and implementing procedures that they expect would be needed for implementation. It has been decided to issue the RFP for the next phase of regulatory support once an appropriate counterpart team from the Zhejiang provincial governmen.t agencies can be constituted. This is expected to 9 The agencies involved are: The State Economic and Trade Commission (SETC); The State Power Corporation (SP); The Zhejiang Provincial Pricing Bureau (ZPPB); The Zhejiang Economic and Planning Commission (ZEPC); and the Zhejiang Provincial Electric Power Bureau (ZPEPB). 10 Funded under the PHRD grant for project preparation.  Page 41 be possible by end- 1999. For the present, agreement has been reached with ZPEPC to include around US$ 3 million in the project for regulatory framework implementation. F. Upgrading Management Systems and Staff Capabilities 19. In order to develop the commercial capabilities required to operate in a market environment, management systems and staff skills need to be upgraded. The main elements of this effort include: * Financial Management Information Systems (FMIS) * Generation Planning Systems and Training * Tariff Study and Training * Management Training Program * Corporate Intranet Financial Management Information Systems (FMIS) 20. Under the earlier Zhejiang Power Development Project, ZPEPC contracted Coopers & Lybrand (now Price Waterhouse Coopers - PWC) to develop the system requirements and detailed design of its Financial Management Information System. This was completed and implementation formally launched in September 1998. 21. The main elements of the on-going FMIS implementation involves: (a) Refining the business requirements for financial information and incorporating them in a new accounting policy and manual. (b) A new chart of accounts and budgeting system. (c) Selecting an appropriate Enterprise Resource Planning (ERP) software package and new hardware systems - SAP has been chosen for implementation on an IBM client- server platform. (d) Introducing the SAP system for a new general ledger, consolidation of accounts, financial management, budgeting, project accounting, management reports, fixed assets, accounts receivable and accounts payable. This is based on four SAP modules - Financial Information (FI), Cost Accounting (CO), Asset Management (AM), Project Management (PS). 22. ZPEPC has made good progress in towards the pilot implementation of the new FMIS in six sites: (a) ZPEPC Headquarters and Shaoxing Power Supply Bureau (trial operation commenced in June 1999) (b) Ningbo Power Supply Bureau and Beilungang Power Plant (trials to begin in mid- August 1999) (c) Hangzhou Power Supply Bureau and Banshan Power Plant (trials to begin in September 1999) 23. The trials are expected to be completed during the first quarter of 2000.  Page 42 24. ZPEPC is preparing a broader program for expanding the FMIS system. First, two new SAP modules are to be acquired - the Preventive Maintenance (PM) and Materials Management (MM) modules. Second, the system will be implemented in seven more municipal power supply bureaus, two or more power stations, and in subsidiary companies (i.e. Fuel Supply Company, Construction Company and Materials Supply Company). While it was originally planned to finance the next phase of FMIS implementation under the Tongbai Project, it is now planned to utilize savings realized during the implementation of the Zhejiang Project. Estimated cost the next phase is US$6 million. Generation Planning Capacity Building 25. Generation planning techniques were first introduced into China in 1986 under the first Zhejiang project (i.e. Beilungang Thermal Power Project). Planning techniques and technology were transferred to Beijing Economic Research Institute (BERI). BERI has successfully provided consultancy services in this field to the Chinese power sector since that time. 26. Subsequently, the Zhejiang Power Development Project, transferred transmission and distribution planning technology to provincial and municipal planning departments and design institutes." Based on the success of these earlier programs, Zhejiang have requested technical assistance in generation planning at the provincial level. 27. The Tongbai Pumped Storage Project will include capacity building assistance in generation planning. The staff of ZPEPC, the future Zhejiang regulatory body, and associated agencies will be trained in the use of modeni methodology and software for electricity generation development planning. These objectives will be achieved through: (a) selection and procurement of appropriate software and hardware for power system generation planning; (b) development of a least cost power system expansion plan for the Zhejiang province for the next 10-15 years; and (c) training of the staff in power system planning. 28. A key principle to be followed would be that the methodology adopted and the software to be acquired be appropriate for the future competitive market environment in electricity generation and later in supply. The software wvill be used for indicative system development planning, evaluation of investment proposals, and tariff regulation. 29. A detailed terms of reference has been prepared and the SPN was published in the July 16, 1999, Issue No 514. The Request for Proposals will be issued October 1999. It is expected that the consultants will be selected and mobilized in February/March 2000. Tariff Study and Training 30. Power pricing principles were also studied under the Beilungang Thermal Power Project, which led to a general awareness of the princiiples of marginal cost pricing throughout China. However, until recently various constraints have impeded the introduction of cost based price structures at the consumerlevel. These included the multiple track pricing system and the local "1 The success of the distribution and transmission planning capacity building effort in reflected in: (i) the wider adoption of the computerized distribution planning system, piloted for Hangzhou and Ningbo - over a two-year period the system will be transferred to 55 municipal and county level distribution entities (with the purchase of additional "keys"); (ii) the computerized transmission planning system is now being extensively used by ZPEPC, and was used to designi the transmission component of the proposed Tongbai project.  Page 43 level surcharges which tended to grossly distort structures which had been finely tuned at the wholesale level. With the banning of local surcharges and approval of the provincial pricing commission of a unified tariff structure for Zhejiang, the opportunity now arises to refine power pricing structures at the consumer level. In addition as distribution sector rationalization proceeds and market implementation is advanced, the efficient cost reflective consumer tariffs are becoming more important. In view of these factors, ZPEPC have requested technical assistance to develop capabilities within ZPEPC and its affiliated and the provincial regulatory staff to: (a) evaluate, compute and implement a unified consumer tariff structure applicable to the whole province. (b) develop a basis for electricity retail pricing regulation, and undertake future tariff reviews and revisions. (c) define an implement viable transition strategy. 31. Technical assistance will be provided under the Tongbai Pumped Storage Project to provide training in principles and methodologies of consumer tariff regulation to relevant personnel in the different Power Supply Bureaus and the regulatory body. 32. This work will be focused on the downstream segment of the power supply chain, i.e., from the bulk supply points to the end-users. A detailed terms of reference has been prepared and the SPN was published in the July 16. The Request for Proposals will be issued October 1999. It is expected that the consultants will be selected and mobilized in February/March 2000. Management Training Program 33. A program of management and staff training has been developed to upgrade the management and commercial skills of staff. The program is designed to expose as many staff as possible to best practice in utility management and governance. Table 3, provides a brief description of the program. A budget of 2.5 million US$ has been provided for the training program under the Tongbai Project. Table 3: Description of Management Training Program No. of Persons Schedule to be Trained 1 Senior Management Training 2 groups x 15 2001-02 (2 to 3 year MBA programs - in persons/group 2003-04 China and overseas) 2 Distribution Company Management 3 groups x 10 Start 2"d semester of 2000 - completion persons/group by end-2001 3 Twinning Arrangements with 2 groups x 2 Start in 2001. Six (6) months per overseas utilities persons/group program 4 Corporate Governance Training 4 groups x 10 Start 2nd semester of 2000. Completion persons/group within four years. 5 Power Market Management 4 groups x 10 Commence in January 2000. Six months persons/group per group 6 Conditional Maintenance 3 groups x 10 Start after technical study is completed. persons/group Completion within 1 8 months.  Page 44 G. Managing Reform hnrrp.nsention 34. A Steering Committee has been establish;d to, dc - c design, preparation and implementation of the planned power sector re-orms in e -7,iaag. Memrbers of the Steering Committee represent the relevant Provincial gi i aoen-s Cenitral government agencies, ZPEPC, the generation companies and power slpp'y ,, _us t.- he Steering Committee is headed by Mr. Chen Jimin, General Director, ZPE1EC. 35. Two working groups have also been formn^led Io. canny out thle rnarket design, corporate restructuring and regulatory tasks required. The firs.L 1 7 a nWGI), will be responsible for the development and implementation of the ger er1 i an rark'-t-his group is being led by Mr. Ying. 36. The second working group (WG2), vw'8iP be resa.e r^r designing and preparing the regulatory procedures and rules to regulate the pcweller seetor i-Zl Jiang - this group is being led by Mr. Chen Qingda. Key participants in fhis working group are stafr onIm the Provincial Economic and Planning Commission and tha Pri -i-,~c: Eureau. wlho will assume the power sector regulatory functions when the )urcau s' aS 37. A Power Market Reform Office has been st , . ghou, and staffed with 5 full-time professionals and support staff. The Power Iark-r Ref-bm ,r C ,6ice vvill be responsible for: (a) coordinating the work of the consultants employed to assist b workig groups; (b) ensuring that the information required by the working groups and tae zacsulltrns are collected in a timely manner.  Page 45 Annex 5: Organization Charts Tongbai Pump Storage Plant Tongbai Management Company ZPEPC (ZPCC) (Zheijiang Pover ConstrucUon Company) Designer Supervisor Consulting Company SBC _ ......................... , Ft x~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~......... . .... .......... Civil Work Contractor I Civil Work Contractor 2 Equipment Contractor I Equipment Contractor 2 Installation Contractor Expand as Required Type title here Type title here Type title here  Page 46 Zhejiang Power Construction Company Manager Chief AccountarntL Schedule 8&Account Construction Equipment & Materials General Office Management Maaem| Management {Planning & Scheduling - - _ -- Quality Commercial Affairs Multiple Services _ Accounting -p Safety Equipment Document Cn _ Finances - [ Schedule 7 Materials _ nternatinal irs ---C t = Technical Documents _Pesonnel & Salary Project Tendering Hydraulic Structuresi {Hydraulic Machinery J Electrical l&C Geology  Page 47 Construction Management for Zhejiang 600 kV Power Transmission and Substation Component Zhejiang Provincial Extra High Voltage Transmission and Distribution Engineering Construction Co. L Director | Construction -_ _ _ Supervision _ - _ -L Design Agency Transnmssion Substation Planning and Procurement Cost & Quality & Team Une Managemen Program & Contract Financial Safety Management Ma mManagement Managemert Management Shaoxing Power Taizhou Power Ningbo Power Wenzhou Power Hangzhou Power Distrbution Co. Distribution Co. Distribution Co. Distribution Co. Distribution Co. Cooperation Cooperation Cooperation Cooperation Cooperation Unk Unit Uni Unk Unkt Subproj Subp rojects Subprejects (contractoI Subprojects Subprojects (contractoij (contracto Yongxi sis (contractor (contractoi Zhuji sis Tongbai to Zhji line Ningbo sls Wenzhousfs Xiaoshan sls Tongbai to Zhuji Une Ningbo to Wenzhou line Ningbo to Wenzhou Line Ningbo to Wenzhou liner  Page 48 Annex 6: Economic Analysis on Tongbai Pumped Storage Power Station China: Tongbai Pumped Storage Project A. Least Cost Analysis 1. A least cost study was carried out by the Beijing Economic Research Institute of Water Resources and Electric Power (<3ERI), covering 1998-2030 (study period) with a focus on 1998-2015. The study was carried out using an optimization model, called GESP, that determines the optimal capacity and generation mix to meet the demand with the minimum cost (net present value of investment and operating cost). It concerns all potential candidates including (a) 300 MW, 600 MW coal-fired units. (b) hydropower stations. (c) nuclear power stations. (d) pumped storage power stations, and (e) 300 MW combined cycle and 100 MW gas turbine fueled by distillate. The price of distillate for the base case was assumed to be US$21 per bbl, corresponding to a crude oil price of US$14 per bbl. The installed capacity of Tongbai station shared by other provinces (municipality) in east China region was modeled by an exported peak power. With 12% of social discount rate, the calculation shows that the proposed project is the first candidate of the least-cost generation expansion program. For the case without Tongbai project, the first alternative investment of the least-cost generation expansion program would be 11 * 100 MIW gas turbine units. 2. Sensitivity analysis confirmed the robustness of the proposed project, which remains the first investment of the expansion program under a wide range of assumptions: (a) The project will be still required by year 2004-2005 even if the electricity growth rate would slow from the projected 6.6% to 5.5% in 1999, from 7.8% to 5.5% in 2000, and from 7.1% to 5.0% during 2001 - 2005; (b) The project will be still required by year 2004-2005 even if the daily minimum load rate and daily average load rate are 4% higher than the base case; (c) The project would be still required by year 2004 - 2005 even if the investment of gas turbine were decreased to 1740.0 Yuan/kW; (d) The project would be less economical than gas turbine units only if the fuel price of the latter were 22.0% lower than the base case (i.e. corresponding to a crude oil price of US$11.50 per bbl); (e) The project would be less economical than 600 MW coal-fired thermal plant only if the investment cost of the latter were 33% lower than the base case (3666 Yuan/kW compared to 5471 Yuan/kW); (f) The project would not be the first investment of the Zhejiang power generation system only if its investment cost were 19% higher than the base case (3760 Yuan/kW compared to 31665 Yuan/kW); (g) The project would be still required by year 2004 - 2005 if the coal price increased by 10% and oil price decreaLsed by 10%; (h) The project would be delayed by 1 year under the combination of low load growth in case (a), coal price increased by 10%, oil price decreased by 10% and project's investment cost increased by 10%;  Page 49 3. The power development program and the balance between power demand and supply are presented as table 1. B. Economic Internal Rate of Return 4. The economic internal rate of return (EIRR) for the proposed project was calculated based on demonstrated "willingriess to pay". The generation cost of Tongbai project at 15% capacity factor is 0.626 Yuan/kWh composed of 0.432 Yuan/kWh for investment cost, 0.057 Yuan/kWh for O&M cost and 0.137 Yuan/kWh for pumping cost. The current power purchase price of 0.80 Yuan/kWh for combined cycle units running 2,900 hours per year (33% capacity factor) was assumed to be a conservative proxy of "willingness to pay". The calculation yielded an EIRR of 16.0%, which is higher than the 12% social discount rate. C. Dynamic Benefits Analysis 5. The chronological simulation was carried by a generation optimal dynamic simulation model, called GODS. The calculation indicates that whatever the Tongbai pumped storage power station will be built or not, the Zhejiang grid currently has enough fast ramping capacity to keep its frequency in a rational range. The construction of Tongbai project can improve system reliability. If the dynamic benefit of EENS reduction is incorporated into project economic analysis, the EIRR increases from 16.0% to 16.3%. E. Project Risk 6. To complement the above deterministic approach, risk analyses have been performed using a probabilistic method to assess the impact of the perceived risk factors that might affect the return of the project. Without Environmental Costs 7. The results of 3000 Monte Carlo Simulations are summarized in Chart 1. Table 5 Expected EIRR and Variance Expected value 15.5% Standard Deviation 1.3% Minimum 10.3% Maximum 19.8% Coefficient of Variation 0.085 8. The expected EIRR, based on the weighted average of all simulated combinations is 15.5% (with a standard deviation of 1.3%), which is 0.5% lower than the base case value without consideration of project risk. The minimum and maximum EIRR, under the considered uncertainties, are 10.3% and 19.8% respectively. The probability of EIRR lower than 12% is 2%.  Page 50 Table 1: Power Balance Table of Zhejiang Province (Unit MW) 1998 2000 2001 2002 2003 2004 2005 2007 2010 2012 2015 PeakLoad 9000 10500 11291 12142 _- 13058 14336 15688 17719 21-28 23846 -28288 Installed Capacity 12223 14998 15201 15422 16351 18052 19836 22336 26236 29236 34736 In Which: Thermal 9621 11695 11818 12039 12868 13569 14168 16168 18568 21568 27068 Hydro 2002 2303 2303 2303 2403 2803 3188 3488 4988 4988 4988 Storage 0 400 480 480 480 1080 1880 2080 2080 2080 2080 Import 600 600 600 600 600 600 600 600 600 600 600 Retirement 0 400 477 480 460 569.5 381 0 0 0 0 Reserve Rate 35.8 42.8 34.6 27.0 25.2 25.9 26.4 26.1 23.2 22.6 22.8 Expanded Capacity 0 2125 680 700 1390 2370 2165 2500 3900 3000 5500 24330 (1) Thernal 0 1725 600 700 1290 1370 980 2000 2400 3000 5500 19565 600 MW Coal 0 1200 600 0 600 600 600 1800 1800 600 4800 12600 300 MW Coal 0 0 0 600 0 0 Q 0 0 0 0 600 i25 MW Coai 0 125 0 0 0 0 0 0 0 0 0 125 Co-generation 0 0 0 100 0 0 0 0 0 0 0 100 Gas Turbine 0 0 0 0 400 100 0 200 600 400 700 2400 Combined Cycle 0 400 0 0 0 0 0 0 0 0 0 400 Nuclear 0 0 0 0 290 670 380 0 0 2000 0 3340 (2) Hydro 0 0 0 0 100 400 385 300 1500 0 0 2685 Three Gorge 0 0 0 0 0 300 300 300 900 0 0 1800 Huaguangtan 0 0 0 0 0 0 85 0 0 0 0 85 Shanxi 0 0 0 0 100 100 0 0 0 0 0 200 Tankeng 0 0 0 0 0 0 0 0 600 0 0 600 (3) Pumped Storage 0 400 80 0 0 600 800 200 0 0 0 2080 Tianhuangping 0 400 80 0 0 0 0 0 0 0 0 480 Tongbai 0 0 0 0 0 600 600 0 0 0 0 1200 Wulongshan 0 0 0 0 0 0 200 200 0 0 0 400  Page 51 Chart 3 Risk Variables Report for Tongbai 60% Risk Variable No. 1 50% Investmnent 40% Probabllih distnbution: 30% 1 %1 0%150%_Z/45% 20% 1 0 .91 0.951_ 1 | 1.051 . 10% m m