China - Second GEF Energy Conservation Project

Report No. PID10757 Project Name China-GEF Energy Conservation II Region East Asia and Pacific Region Sector Other Power & Energy Conversion Project ID CNPE67337 Borrower(s) Government Of China Implementing Agency State Economic And Trade Commission Address: No.28 West Street Xuanwumen, Beijing, 100053, P.R.C. Contact Person: Mr. Wang Shumao Tel: 86-10-6360-1354 Fax: 86-10-6360-1353 Email:pmo@public.bta.net.cn Environment Category F Date PID Prepared September 14, 2001 Projected Appraisal Date March 2002 Projected Board Date June 2002 1. Country and Sector Background Energy Conservation Efforts in China. Improving energy efficiency has been a cornerstone in China's energy policy for about 20 years. It has long been recognized that continued, long-term economic growth is not physically, financially or environmentally sustainable without dramatic further improvements in energy efficiency. Initially, the Chinese Government employed a series of monitoring and quota mechanisms through the planned economy to promote energy conservation and curtail at least the most glaring cases of energy waste. More recently, the Government has deployed a mixture of tools, better catered to the developing market economy, which are similar to those employed in most market economies with sophisticated energy conservation policies. These include the economic framework, regulation, technology development, and market-based initiatives. China has collaborated with a variety of international organizations on each of the above agendas, with a number of important and worthwhile projects. For its part, the Bank has supported the technology transfer agenda, through the development of more energy-efficient small coal-fired boiler models under the GEF-supported China Efficient Industrial Boilers Project. The Bank also is discussing possible support for the implementation of building energy efficiency regulations, as part of a possible future Building Energy Efficiency and Heat Reform Project. However, the main focus of the Bank's effort, based on the findings of substantial upstream sector work and following the strong desire of Government counterparts, has been to help develop means to better take advantage of market forces to implement financially attractive energy saving renovation projects. The effort to obtain results using market forces follows the slogan coined by one Chinese counterpart, "Conserve  energy and make money." The sector work, together with other market analyses and many experiences in project implementation, has shown that there is very large potential across China for "classic" energy conservation renovation project which will yield sound life-cycle financial returns today. However, a large part of this potential remains untouched. The reasons for this counter-intuitive dilemma, also found in other countries, include inadequate information, real or perceived insignificance of small projects, high transaction costs, technology risk, technology transfer barriers, and difficulties in arranging financing. The China Energy Conservation Project, and this proposed Phase II effort, are targeted squarely on the development and implementation of solutions to at least partially overcome these barriers to implementation of financially attractive energy conservation investment. The EC/GEF/IBRD China Energy Conservation Project. Approved by the Bank's Board in March, 1998, the objective of the $151 million China Energy Conservation Project is to achieve large, sustained and growing increases in energy efficiency, and associated reductions in growth of carbon dioxide emissions and other pollutants, by (a) introducing, demonstrating and disseminating new project financing concepts and market-oriented institutions to promote and implement energy efficiency measures in China, and (b) developing a more efficient national energy conservation information dissemination program. The project is designed to assist in the transition of China's energy conservation activities from a system based on planned economy concepts to a more market-oriented system, which can be sustained over time and grow with China's economy. Energy performance contracting as practiced by the three EMCs under the project, can overcome many of the constraints described previously. By providing design, procurement, financing, and installation services, and guaranteeing positive-cash flow performance as a condition for any payment, the EMCs can overcome many of the problems faced by enterprises with energy conservation projects. Project implementation to date has been fully satisfactory, and the three EMCs, founded in Beijing, Liaoning and Shandong, are successfully developing growing businesses. Following publicity by SETC of the efforts so far, some new EMCs are beginning to form, and more groups and business are becoming interested in capturing some of the potential for energy performance contracting. 2. Objectives The objective of the proposed project is to expand domestic investment in energy efficiency projects through the aggressive development of China's nascent Energy Management Company (EMC) industry, thereby achieving large-scale energy efficiency improvements and associated reductions in the growth of carbon dioxide emissions and other pollutants. The EMC concept has been successfully demonstrated under Chinese conditions by three large pilot EMCs established in 1997 and developed under the ongoing EC/GEF/IBRD China Energy Conservation Project. Additional EMCs are now endeavoring to emerge, and interest in developing this type of business in China is running high. To foster the broad development of an EMC industry in China quickly will require (a) the introduction and growing participation of China's domestic banks in the business, as the primary source of credit, and (b) massive dissemination of the concept and experiences achieved, supported also with practical technical assistance and operationally-focused training for emerging new EMCs. This project seeks to meet these requirements. -2-  3. Rationale for Bank's Involvement This project conforms fully with the CAS goals to adjust the balance between energy development and conservation and improve the environmental sustainability of infrastructure. The project is also consistent with the objectives of GEF Operational Program 5: Removal of Barriers to Energy Efficiency and Energy Conservation. Section 5.7 of OP5 includes support for activities that lead to sustainable "win-win" results that demonstrate local, national, and global benefits through removal of barriers. 4. Description The proposed project includes two components: (a) an EMC Service Component, designed primarily to provide in-depth, practical technical assistance to new and emerging EMCs on development of their businesses, and (b) an EMC Loan Guarantee Program, designed to provide new and emerging EMCs with enhance opportunities to receive loans from domestic banks, and to engage the banks in the development of a sustainable EMC industry.EMC Service Component. This component will support the development and key initial activities of an EMC Service Group, which will operate as a Western-style trade association to provide a range of services to member EMCs or prospective member EMCs. The objective of the EMC Service Group is to assist in the creation of a sustainable MEC industry in China, by providing technical assistance and training services to emerging EMCs, promoting the EMC business in society at large, and developing a cohesive, mutually supporting network among member EMCs. EMC Loan Guarantee Program. A new EMC loan guarantee facility will be established under the project in China and operated on a commercial basis with national coverage, to enhance the ability of EMCs to obtain commercial loan financing from domestic banks. The facility will be operated by a Guarantee Company (most likely newly established specifically for the project), working in strategic partnership with several major participating domestic banks, who will receive substantial technical assistance under the project. The facility must be operated on commercial terms, seeking to preserve and grow its capital base be controlling costs, price risk correctly, charge appropriate fees, and maintain prudent treasury management. 5. Financing Total ( US$m) GEF financing proposed for this project: $26 million Total Project Cost 6. Implementation The SETC will be responsible for coordination of project implementation, working together with the Ministry of Finance and other agencies and research units. The SETC's Project Management Office (PMO), established in 1997, has been effectively conducting project coordination activities for the first phase of the China Energy Conservation Project, and will continue its work during this second phase. The details of project implementation, however, with be the responsibility of the EMC Service Group, and the proposed Guarantee Company in conjunction with its participating bank partners. 7. Sustainability The development of a self-sustaining (and growing) EMC industry in China is the objective of this project. The project has been designed -3 -  specifically to achieve this objective, by aiming to involve domestic banks as the financiers of the industry, thus completing the full necessary market framework, and by developing a service-oriented EMC Group/Association for mutual EMC assistance. 8. Lessons learned from past operations in the country/sector Experience in other Bank/GEF projects, and in a variety countries, in promotion of EMCs/ESCOs has been fully reviewed and incorporated in the project design, particularly through active involvement of the task team in the Bank's Energy Efficiency and Environment Thematic Group. Contingent finance arrangements developed in IFC's Hungary Energy Efficiency Guarantee Project and the proposed GEF Romania Energy Efficiency Project were closely reviewed, and elements from these projects have been incorporated in the project design. The task team has also exchanged views with Brazilian experts involved in the GEF/IBRD Brazil Energy Efficiency Project, who also are considering the development of a loan guarantee program for ESCO projects. As planned prior to submission of this project to the GEF Council, the PMO and Bank team have also completed, particularly through the Mid-Term Project Review, (a) an evaluation of implementation results of the initial pilot project in the EMC Demonstration Component, (b) an assessment of lessons learned, identification of issues requiring resolution, and proposed solutions: (c) conferences and consultations on EMC results with the domestic financial community; and (d) arrangements for suitable counterpart financing.Indications of borrower and recipient commitment and ownership Borrower commitment and ownership is high. Development and expansion of the EMC industry has become one of the main directions of the Government's program to align its energy conservation strategy with the developing market economy. Development of this project has involved many consultations with various stakeholders, to develop a broad consensus of approach. SETC has already formed the EMC Service Group, and has engaged high-quality consultants and experts from different sectors to undertake project preparation.Value added of Bank and Global support in the project. With the active support and involvement of GEF staff, the Bank and Chinese teams have worked exceptionally closely since 1995 to develop energy performance contracting as a new investment mechanism in the Chinese market. The joint team has built new institutions, adapted foreign models to Chinese conditions, and addressed and solved a wide range of issues, some of which had never been encountered before. It is very important to continue the GEF/Bank/Chinese joint effort on past the initial, successfully demonstration phase, through to the most critical, dissemination and expansion phase. This will require additional institutional building challenges and additional innovative arrangements, building upon the relationships already developed. As with the first phase of the project, GEF support of Phase II fulfills a role which no other entity can. There is no alternative investor willing and able to place sufficient funds in the high-risk position of the proposed new guarantee facility capital reserve, in order to achieve the potential broad global benefit expected. 9. Program of Targeted Intervention (PTI) N 10. Environment Aspects (including any public consultation) Issues : This financial intermediation project will result in major positive impacts on the environment, in terms of improved energy - 4 -  efficiency, reduced air pollution, and reduce greenhouse gas emissions. No major adverse environmental issues are associated with the project. 11. Contact Point: Task Manager Robert P. Taylor The World Bank 1818 H Street, NW Washington D.C. 20433 Telephone: (202) 458-2446 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 2,2001 - 5 -