China - Hubei Hydroelectric Project

Report No. PID9399 Project Name China-Hubei Hydropower Devt. In Poor Areas Region East Asia and Pacific Region Sector Hydro Project ID CNPE68049 Borrower(s) China Implementing Agency Hubei Provincial Finance Bureau Address: 8 Zhongbei Road, Wuchang District, Wuhan City, Hubei 430071, China Contact Person: Mme. Guo Shimin Tel: (86-27) 8784-9682 Fax: (86-27) 8784-9682 Email:guoshimin@public.wuhan.hubei.cn Hubei Provincial Planning Commission Address: 17 Dong Yi Road, Shuiguohu, Wuchang, Wuhan, Hubei, China Contact Person: Mr. Chen Hui Tel: 86-27-87815800 Fax: 86-27-87364130 Environment Category A Date PID Prepared October 23, 2001 Projected Appraisal Date November 15, 2001 Projected Board Date March 26, 2002 1. Country and Sector Background Transitioning the Power Sub SectorBackground. Until the early 1980s, China's power systems were entirely government owned. For the most part, power was provided through a centralized government department with operating units at the province, prefecture (or municipality) and county levels. However, because not all rural areas were connected to main grids, local systems also grew up at county level and even at local government levels (township and village) Governments down to county level are considered to be part of the Chinese Government. Below the county level, governments are considered to be representatives of collectives, which were formerly organized into communes (now referred to as townships) and brigades now referred to as villages. Except for local government systems, investments were centrally decided and financed through budget allocations. Prices were centrally controlled and covered only a small portion of supply costs. Private ownership of power assets was illegal. Power shortages were endemic.Over the two decades since 1980 there have been very great changes. The sector is now largely corporatized and its ownership is diverse, budget allocations have been phased out, subsidies eliminated and electricity prices are in line with or above marginal supply costs in most grids. This has enabled the sector to grow dramatically with installed capacity and generation quadrupling to over  300 GW and about 1250 TWh, such that China's power sector is by now the second largest in the world, and supply and demand are basically in balance.The provincial power companies still form the core of the current system. These state owned entities own and operate the main transmission grids, act as single buyers in the purchase of power from generators (except for "embedded" generation) and its sale to distributors, and continue to have substantial interests in generation and distribution. The single buyer structure has showed strains in recent years and the Government therefore intends to introduce and expand competition, starting with generation in the short term and eventually extending to retail competition in the longer term (5 to 10 years). This goal is ambitious, and impediments to even initial implementation include the following: Lack of Clear Strategy for Market Development. While pilot markets have involved single provinces, the possibility of initial implementation of regional markets, at least in some areas has been mooted. The Government needs to articulate a long term-vision and a strategy for movement towards it, recognizing the variety of provincial and regional systems in China and the current status of reform in each area. Incomplete Separation of Generation from Transmission. The Government has mandated separation of generation and transmission, but the status of this separation, and its effectiveness, varies among provinces, and the potential for conflict of interest remains. Lack of Strategy for Distribution Restructuring. Little consideration has yet been given to separation of distribution from transmission and the structure of distribution and supply.Consumer Pricing Issues. Along with distribution restructuring, regulators will also have to deal with distribution pricing and consumer tariff structures. Lack of Required Institutional Infrastructure. Market implementation will require considerable institutional infrastructure: market codes, trading and settlement systems and training of market participants. Power System Infrastructure Weaknesses. Effective markets require strong transmission systems and initial generation mixes which are reasonably optimum. This situation does not prevail in many Chinese systems.Inappropriate Regulation Mechanisms. Perhaps the greatest impediment to implementation of competitive power markets is that the current regulatory system is still reflective of a command economy and is inappropriate to the regulation of competitive marketsUnreformed County and Locally Owned Generation. Separation of generation and the transmission has extended to the county level with provincial power companies taking over management of distribution and making substantial investments in its reinforcement. However, this did not cover generation owned at the county level and below. With increasing efficiency of provincially dispatched generation, this segment of the power sector offers the greatest potential for efficiency improvement. Similarly, from the institutional viewpoint, sector reforms over the past two decades have left the county and locally owned generation virtually untouched, and there is considerable potential for reform. Government Strategy. Since 1993 the Government, with Bank assistance, has been actively engaged in overall restructuring of the power sector. In that year the Bank worked with the Government to carry out a study "Strategic Options for Power Sector Reform in China" which provided the basis for the Ministry of Electric Power strategy of "corporatized restructuring, commercialized operation and legalized regulation". This was followed by a 1996 study "Power Sector Regulation in a Socialist Market Economy" which recommended staged implementation of regulatory reform over the period 1996 to 2005. In 1999, Government strategy began to shift towards competitive markets, and further studies - 2 -  over the 1999-2000 period, again assisted by the Bank culminated in the publication of "Fostering Competition in China's Power Markets". In 2000, State Development Planning Commission (SDPC) was entrusted by the State Council to review alternative options and recommend the way forward. The Bank again assisted in organizing a workshop "New Waves of Power Sector Reform in China" and published the proceedings in English and Chinese. Consultants are currently being selected for a new study to assist State Power Corporation in devising a generation separation and divestiture strategy. With the move to competitive markets, an update of the regulation strategy is appropriate and the Bank intends to shortly issue a paper to guide the Government in formulating policies in this area.Policy development at the central government level has been accompanied by piloted implementation of reforms at the provincial level, with implementation experience feeding back into new policy development. For example, the recent power market dialogue has drawn on studies and pilot implementation associated with the Tongbai Pumped Storage Project and the East China (Jiangsu) Power Transmission Project. The Tongbai project also includes transmission pricing, distribution pricing, generation planning and consumer pricing studies, the results of which will feed into government policy development. Similarly, the proposed Yi-Xing Pumped Storage Project will include market design and implementation, and distribution restructuring.The Government is addressing the transmission infrastructure issue with large investments in high voltage transmission to transmit power from west to east, and the Bank has assisted in some of these investments and in reinforcement of the 500 kV grids in East China, where power markets are piloted. The generation mix issue is being addressed through large hydropower development (and its transmission to coastal markets), development of combined cycle power plants based on natural gas and through development of pumped storage plants. The Bank has also assisted with the latter. Conversion to Clean Fuels and Energy EfficiencyClean Fuels. China's power sector has long been dominated by coal-fired generation with concomitant large emissions of S02, NOx, particulates and greenhouse gases with consequent adverse impacts on health, agricultural production, and global warning. Recognizing this, the Government in recent years has (a) stepped-up the development of large scale hydropower; (b) mandated the retirement of about 10 GW of small, inefficient and polluting, coal fired units by 2000, (c) used S02 emission taxes and increased requirements for flue gas de-sulfurization on new power plants; and (d) planned increased usage of natural gas by facilitating its transfer by pipeline from the far west, development of offshore reserves and import of LNG to coastal centers. In the 10th Five Year Plan (FYP), covering the period from 2001 to 2005, the energy sector objective is to change the structure of energy supply by shifting away from coal, developing clean energy sources and increasing efficiency. For the first time, green house gas (GHG) emissions and climate change issues were addressed in the plan. In addition to large hydropower development, Government also wishes to accelerate the development of small hydropower and other renewable energy sources (referred to hereafter as "renewables"). A component of the 10th FYP is a plan to increase the share of renewables through the use of a "mandated market share" (MMS) policy and supporting measures such as tax incentives. Impediments to such development include the following:High Unit Energy Costs. Mechanisms are needed to internalize costs of environmental externalities.High Transaction Costs. Small capacities associated with renewables result in high unit transaction costs making them unattractive for developers and - 3 -  financiers. Weaknesses of Potential Developers. Counties and local governments are very interested in developing their small hydropower resources because of the effect on economic development and fiscal revenues. However the local generation companies lack institutional and financial capacity and creditworthiness, as referred to earlier.Mismatch between debt maturities and asset life. This is particularly onerous for hydropower where new SPDC tariff policies assume loan maturity approaching asset life (18-25 years) whereas maturities available from commercial banks are typically only 10 years beyond construction period.Cost-based pricing Formula with Low Allowable Returns on Equity. This provides no incentive for development of even the most economical resources, particularly in view of other barriers to development..Weak Manufacturing and Service Industries. Despite the large installed capacity of small hydropower (>20 GW), this is based on outdated technology and inefficient operational and management practices. For other renewables like windpower, commercial capacity is still in initial stages of development. These impediments will be the target of government policies currently being developed under the Bank/GEF China Renewable Energy Scale-up Program (CRESP). Energy Efficiency. Focusing on demand side energy conservation (awaiting Bob Taylor input)Bank Strategy for Clean Fuel Transition and Energy Efficiency. [To be based on annex. Preliminary version needs to include Bob Taylor input]Energy Resource Development in Western AreasThe Government has embarked on a Western Region Development Program to reduce poverty and regional inequality that threaten social stability. Since a large proportion of China's energy resources, particularly large hydropower, gas and renewables, are located in western areas, assistance in development of these resources would support the government strategy. Development of hydropower and renewable resources would be particularly beneficial, since economical resources are usually located in mountainous terrain or remote areas. This type of terrain, which typically involves land shortages and difficult access, is also a primary determinant of poverty. Factors which inhibit such energy resource development or minimize its impact on poverty are the following:Impediments to Renewable Development. Since renewables are largely located in western areas then the impediments to rural development listed above also inhibit development of western energy resources. Inappropriate Benefit Sharing Mechanisms. Development of energy resources does generate economic activity in the project area during the construction period, but there is little employment during the operating period. Income taxes could provide a continuing return to resource owning areas, but under the current fiscal system the level of government receiving income tax relates to the ownership of the developer. Since companies or governments in western areas generally do not have the financial resources to develop their energy resources and transfer them to markets in the east, they are discouraged from allowing others to do so since they do not receive tax benefits (or returns on equity). Revision of income tax sharing arrangements, which is under consideration, may partly deal with this problem. However, the appropriate mechanism for providing resource owners with a return for their value, is appropriate royalty arrangements. In the case of gas, royalties do accrue to the central government but there are no arrangements for sharing these with regional and local governments. In the case of economical development of hydropower, an energy cost less than that of thermal alternatives implies an economic rent which is normally captured by royalty impositions. However, while hydropower royalties and royalty sharing mechanisms are being introduced in other parts of the - 4 -  world, notably Canada and South America, they do not yet exist in China.Need for Targeting of Income to Poverty Programs. While generation of fiscal or royalty income in resource owning areas will certainly generate economic development in those areas, it should ideally be accompanied by programs which devote a proportion of this income to residual pockets of poverty. Bank Strategy for Energy Resource Development in Western Areas. Bank strategy for assisting the Government in these areas is under development. To start the process, a study to analyze the distributional impacts of energy development in western areas has been recently commenced. This will draw on the experiences of other countries in terms of creating incentives for such developments and maximizing development impacts to the undeveloped areas. The CRESP project referred to above will also examine the mechanisms for pricing renewable energy to achieve the same objectives.Consistent with the approach used for other energy sector objectives, proposed reforms will be piloted through lending operations involving GEF where appropriate. 2. Objectives The project has three objectives: (a) expand electric power generation capacity in Hubei in an economically and environmentally sustainable manner in order to facilitate economic growth; (b) comercialize county level generation companies in Hubei; and (c) contribute to poverty alleviation efforts in poor communities in Hubei. 3. Rationale for Bank's Involvement The project will contribute to the Bank's three main objectives in the energy sector: transitioning the state owned energy sector to a diversely owned market based system; conversion to clean fuels and increasing energy efficiency; and raising incomes in poorer western areas by assisting them to develop and export their energy resources. The investment components are appropriate vehicles for Bank investment in that private sector development is not appropriate. Hydroelectric and pumped storage projects are difficult to develop privately because of: the high proportion of civil costs that 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 that can rise rapidly in fast-changing political, economic and social environments; and environmental and resettlement implications that deter private developers and lenders. Hydroelectric schemes of the size of the proposed subprojects have been developed privately but not without a high degree of public involvement.The proposed hydropower evelopments are being developed by independent power producers which, while publicly owned, are not drawing on public finances for their equity investment. Rather they are self-financed from existing small hydropower generation income. While they should attract local debt financing, local commercial banks and even the China Development Bank are risk averse, because of their inexperience with risks associated with hydroelectric development and because of the relatively weak balance sheets of the county companies in comparison to provincial companies. World Bank involvement in the project would ensure that: The technical design, construction practices and equipment selected for the hydroelectric projects are in accordance with leading international practice and standards;The institutional arrangements for project implementation, would assure cost-effective, timely implementation - 5 -  and the quality of the products;The legal and commercial arrangements are appropriate;The LLCs developing the project and their majority owners are established and operate in accordance with sound commercial practice;Environmental impacts of the projects are properly evaluated and appropriate management and mitigation measures are implemented;Resettlement arising from the subprojects and the project itself are treated as an opportunity for development of affected communities and the poor people in the host counties.It is intended that such developments would provide a model for future similar future developments having less recourse to government and Bank support. 4. Description 1. Dongping Hydroelectric Power Station including: (a). Construction of a hydroelectric power station at Dongping, Xuan-en County, in Hubei, including: (i) a single purpose concrete arch dam 134 meter (m) high with a crest length of 268m; (ii) an underground power house with installed capacity of 110 (2x55) megawatts (MW); and (c) an associated step-up substation. (b) Carrying out of a program of institutional strengthening of Dongping Company, including: (i) development and implementation of a financial and management information system; and (ii) provision of training to Dongping Company staff in project management and hydropower station operation. (c) Development of a plan for enhancement of poverty alleviation efforts in the Dongping project area to be funded from fiscal revenues accruing to Xuan-en County as a result of the Project. (d) Compensation, resettlement and rehabilitation of approximately 3,047 Affected Persons. 2. Lajitan Hydroelectric Power Station including: (a) Construction of a hydroelectric power station at Lajitan, Laifeng County, in Hubei, including: (i) a single purpose 39 m high single purpose concrete gravity dam with a crest length of 200m; (b) a surface power house with installed capacity of 36 (3x12) MW; and (c) an associated step-up substation (b) Carrying out of a program of institutional strengthening of Lajitan Company, including: (i) development and implementation of a financial and management information system; and (ii) provision of training to Lajitan Company staff in project management and hydropower station operation. (c) Development of a plan for enhancement of poverty alleviation efforts in the Lajitan project area to be funded from fiscal revenues accruing to Laifeng County as a result of the Project. (d) Compensation, resettlement and rehabilitation of approximately 2,565 Affected Persons. 3. Songshuling Hydroelectric Power Station including: - 6 -  (a) Construction of a hydroelectric power station at Songshuling, Zhushan County, in Hubei, including: (i) a single purpose concrete gravity dam 65m high with a crest length of 128m; (ii) a surface power house with installed capacity of 50 (4x12.5) MW; and (iii) an associated step-up substation. (b) Carrying out of a program of institutional strengthening of Songshuling Company, including: (i) development and implementation of a financial and management information system; and (ii) provision of training to Songshuling Company staff in project management and hydropower station operation. (c) Development of a plan for enhancement of poverty alleviation efforts in the Songshuling project area to be funded from fiscal revenues accruing to Zhushan County as a result of the Project. (d) Compensation, resettlement and rehabilitation of approximately 465 Affected Persons. 4. Xiakou Hydroelectric Power Station including: (a) Construction of a hydroelectric power station at Xiakou, Nanzhang County, in Hubei, including: (i) a multi-purpose concrete arch dam 85m high with a crest length of 195m; (ii) a surface power house with installed capacity of 30 (2x15) MW; and (c) an associated step-up substation. (b) Carrying out of a program of institutional strengthening of Xiakou Company, including: (i) development and implementation of a financial and management information system; and (ii) provision of training to Xiakou Company staff in project management and hydropower station operation. (c) Development of a plan for enhancement of poverty alleviation efforts in the Xiakou project area to be funded from fiscal revenues accruing to Nanzhang County as a result of the Project. (d) Compensation, resettlement and rehabilitation of approximately 1,043 Affected Persons. 5. Financing Total ( US$m) IBRD 125 OTHER 55 BENEFICIARIES 52 Total Project Cost 232 6. Implementation The Hubei Provincial Planning Commission had been the coordinating agency and took the lead for project preparation. Since June 2001, this role has been taken over by the Hubei Provincial Finance Bureau. The Provincial Government has approved the establishment of a provincial level Project Management Office (PMO) to oversee and coordinate the overall project implementation. This PMO will be hosted by the provincial Finance Bureau will include representatives from relevant provincial departments - 7-  including the Finance Bureau, Planning Commission, Pricing Bureau, Water Resources Department, Audit Bureau, Provincial Electric Power Company, Poverty Alleviation Office, Resettlement Office, Environmental Protection Bureau, and Land Administration. The PMO will be headed by one director and two deputy directors as well as professional staff experienced in project management, hydropower engineering, financial management, environment, resettlement and social aspects. The PMO will have four units responsible respectively for: project and technical related matters (including resettlement and environmental protection); finance; planning; and procurement.At the county or project level, each project company will act as a project-level PMO to be responsible for the actual implementation of their respective components.The Hubei Investigation and Design Institute (HIDI) is the designer for all four hydropower developments. An independent review of the design has been carried out by the Changjiang Water Resources Commission (CWRC) Design Institute. A Panel of Experts consisting of 6 international and national specialists has been formed to provide periodic, independent reviews of the subprojects during final design and construction. Two domestic engineering firms will also be employed to supervise construction and to fulfill the functions of the "engineer" in accordance with the FIDIC conditions of contract. The Chinese Research Academy of Environmental Sciences has been employed to renew and upgrade environmental assessments (EAs) and develop the environmental management plan (EMP). Environmental Mangement /Monitoring Office (EMOs) will be set up at project level and will be responsible for the implementation of EMP. The East China Investigation and Design Institute (ECIDI) has helped in preparation of respective Resettlement Action Plan (RAP). ECIDI will also conduct external monitoring and evaluation of resettlement work during the project implementation.For procurement, the International Tendering Company of CNTIC has been employed as the procurement agent. CWRC's Design Institute isl be responsible for preparation of the technical parts of the bidding documents. 7. Sustainability Project benefits will result from the nonconsumptive use of a renewable natural resource--water. With little potential for consumptive exploitation of water quantities upstream of the project, this resource will not significantly diminish in quantity over time, and the project will include environmental provisions to control quality degradation. Sustainability is therefore primarily dependent on obtaining a high-quality design of key project features, assuring quality in construction of the dam and hydropower plant, and establishing properly trained and funded operations and maintenance entities to avoid having project investments deteriorate over time. Financial sustainability is assured since allowable tariffs verified since financial projections based on approved tariffs demonstrate financial viability. Furthermore, tariffs needed to ensure financial viability is less than competitive in comparison with other types of generators. Environmental and social sustainability will be assured by development of adequate environmental management and mitigation and resettlement action plans.Factors critical for the sustainability of project benefits:High-quality design and implementation;Competent operations and management entities with appropriate systems;Purchase of power by the grid at a price necessary to ensure financial sustainability;Successful resettlement of the affected population with full restoration of living standards, and manageable - 8 -  environmental impacts; andEnvironmental management during construction and operation to ensure impacts are mitigated to the maximum practical extent. 8. Lessons learned from past operations in the country/sector Previous hydropower and other water resource development projects have been quite successful. The key lessons learned from past projects include:the need for full commitment and strong ownership of the Borrower, and strong support from local government at different levels;affected people should be involved from the early stages of project preparation and throughout the implementation period, to gain and maintain their support;key policy reforms, conforming to government reform objectives, should be incorporated into the project design; project preparation should include development of detailed organizational and staffing arrangements for implementation;counterpart funding should be committed before implementation, with the direct participation of the provincial planning commission and finance bureau;projects should include institutional development support for the strengthening of the project implementing and management organizations;implementation support to the executing agency should include a competent construction supervisory organization; procurement for major civil works should be started early in the preparation period so that bid award will correspond with loan effectiveness in order to avoid delays and cost overruns;power markets should be carefully assessed and periodically reassessed during project implementation to ensure a demand for output on project completion;the financing package must be appropriate to ensure that tariffs are competitive in the short term as well as economical in the long term; key principles of the power purchase agreement should be established before project appraisal, to ensure full realization of power sales benefits;with regard to resettlement, plans should be further advanced at appraisal stage particularly in regard to economic carrying capability, and cost estimates and funding proposals carefully assessed; in addition planning should involve professional town planners to identify opportunities for maximizing development impacts from the resettlement. 9. Program of Targeted Intervention (PTI) N 10. Environment Aspects (including any public consultation) Issues The four small/medium size hydropower developments will each consist of a concrete dam, above ground or underground power house, switch yards, ancillary facilities, and transmission lines. Because of their limited seasonal storage they will tend to operate on base load in the wet season and peak load in the dry season. Each project will exploit sections of tertiary rivers that are otherwise already dammed downstream, and in the case of Dongping, Lajitan and Xiakou, upstream as well, to generate electricity or impound water for agriculture/municipal water supplies. The existing dams have already had a significant impact on eliminating migratory fish populations from the respective project areas, and reducing the level of productivity within these remaining reaches. Due to the steep mountainous geography of the region, the reservoirs will be long narrow bodies of water, with relatively little inundation of valuable land. The lower elevation valley areas in which each reservoir will be formed provide little in the way of forest resources and, thus, little in the way of suitable wildlife habitat. This is primarily due to the steep rocky terrain and thin soils that support primarily woody shrubland type vegetation. In those areas where terrain and soils are more conducive to -9-  forest growth, decades of human habitation have resulted in native forests being replaced by farmland, orchards, or cultivated commercial forests. The transmission lines will primarily extend across mountainous terrain, but will be designed and constructed so as to take advantage of topographic features so as to minimize the need to remove vegetation. Transmission lines will extend from substations that will be constructed at each damsite, and connect to new substations that will be constructed on vacant wasteland on the outskirts of existing communities.An environmental impact assessment (EIA) and an environmental management plan (EMP) conforming to OP4.01 have been prepared and are summarized in Annex 13. In addition, a Karst Biodiversity Assessment was completed as a supplementary report to the Summary EA, to evaluate the potential impacts on karst features within the project areas, in conformance with OP4.04. The most important impacts are:loss of riverine aquatic environment for a distance of 32 km (Dongping), 33 km (Lajitan), 19 km (Songshuling) and 18 km (Xiakou), and replacement with lacustrine environment;potential dewatering of short sections of river downstream of each dam during dry season operations when reservoirs are being recharged;potential dewatering of the Luxiawan Irrigation Canal immediately downstream of the Xiakou project;exposure of cut and fill slopes to the forces of erosion during construction of the hydropower projects, roads, and resettlement villages;short-term impact of large construction work forces moving into rural areas which have relatively sparse populations at present; some tree cutting and vegetation clearing along short sections of the transmission line rights-of-way, where clearance distances cannot be provided by tower siting on high points of land; andpotential effects of noise and electro-magnetic flux (EMF) from transmission lines and substations. 11. Contact Point: Task Manager Barry Trembath The World Bank 1818 H Street, NW Washington D.C. 20433 Telephone: (202) 458-2891 Fax: (202) 522-1648 12. For information on other project related documents contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http:// www.worldbank.org/infoshop Note: This is information on an evolving project. Certain components may not be necessarily included in the final project. This PID was processed by the InfoShop during the week ending November 9,2001 - 10 -