China - Sichuan Gas Transmission Distribution Rehabilitation Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 12479-CHA GLOBAL ENVIRONMENT FACILITY MEMORANDUM AND RECOMMENDATION OF THE DIRECTOR OF THE CHINA AND MONGOLIA DEPARTMENT OF T-E INTERNATIONAL BANK FOR RECONSTRUCON AND DEVELOPNENT TO THE REGIONAL VICE PRESIDENT ON A PROPOSED GRANT FROM THE GLOBAL ENVIRONMENT TRUST FUND IN AN AMOUNT OF SDR 7.3 MILLION ($10 MILLION EQUIVALENT) TO THE PEOPLE'S REPUBLIC OF CHINA FOR A SICHIUAN GAS TRANSMISSION AND DISTRIBUTION REHABILITATION PROJECT (A COMPONENT OF SICHUAN GAS DEVELOPMENT AND CONSERVATION PROJECT) FEBRUARY 28, 1994 Industry and Energy Operations Division China and Mongolia Department East Asia and Pacific Regional Office MICROGRAPHI''S This document has a restricted distribution and may their official duties. Its contents may not otherwis4 Report No: 12479 CHA Type: MOD  CURRENCY EQUIVALENTS (as of January 1994) Currency Name - Renminbi (RMB) Currency Unit - Yuan (Y) 1 Yuan - 100 fen Y 1.00 - $0.11 $1.00 - Y 8.7 WEIGHTS AND MEASURES 1 meter (m) - 3.28 feet 1 square meter (m2) - 10.76 square feet 1 cubic meter (m3) - 35.3 cubic feet 1 kilometer (km) - 0.62 miles I hectare (ha) - 10,000 squaze meters ABBREVIATIONS AND ACRONYMS bcm billion cubic z,..er CNPC China National Petroleum Corporation ESMAP Energy Sector Management Assistance Program GEF Global Environment Facility GET Global Environment Trust Fund GRG Greenhouse Gas JGF Japanese Grant Facility mem thousand cubic meter MOPI Ministry of Petroleum Industry NEPA National Environmental Protection Agency NPV Net present value PMO Project Management Office PRIF Preinvestment Facility SCADA Supervisory Control and Data Acquisition SEPC State Environmental Protection Commission EPA Sichuan Petroleum Administration T&D Transmission and Distribution UNDP United Nations Development Programme FISCAL YEAR January 1 - December 31  FOR OmCL USE ONLY CHINA SICHUAN GAS DEVELOPMENT AND CONSERVATION PROJECT GAS TRANSMISSION AND DISTRIBUTION REHABILITATION COMPONENT Grant and Project Summary Grantee: People's Republic of China Beneficiary: Sichuan Petroleum Administration (SPA) Amount: SDR 7.3 million ($10 million equivalent) Terms: Grant Financina Plan: Local Foreign Total --- ($ million) ------ Global Environment Trust Fund 0.0 10.0 10.0 SPA/CNPC 35.9 23.8 59.7 IBRD 0.0 53.0 53.0 Total 35.9 86.8 122d7 Economic Rate of Return: Not applicable Ma-ps: IBRD Nos. 25137 and 25138 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  MEMORANDUM AND RECOMMENDATION OF THE DIRECTOR OF THE CHINA AND MONGOLIA DEPARTMENT TO THE REGIONAL VICE PRESIDENT 1. I submit for your approval the following memorandum and recommenda- tion on a proposed Global Environnent Trust Fund (GET) grant to the People's Republic of China for SDR 7.3 million, the equivalent of $10 million, to help finance rehabilitation of the Sichuan gas transmission and distribution eystem in China, a component of the Sichuan Gas Development and Conservation Project ($945 million) to be partly financed by IBRD ($255 million). 2. Background. China has one of the world's fastest growing industrial economies. Over the past decade, its GNP growth has averaged 13 percent per annum and economic growth is expected to remain robust for this decade. Since the growth of energy supply has not kept pace with energy demand fueled by rapid economic growth, energy shortages are acute in the country. With a view to sustain-J.ag both economic development and reduction of air pollution and greenhouse gas (GHG) emissions, efforts to enhance both the supply of cleaner energy resources and the efficiency of energy use have been a cornerstore of the country's energy and environmental policy. 3. Coal has been, and will continue to be, the dominant energy source for China while contributing to increasingly serious environmental concerns, both a-.: the local and globzl levels. Expanded use of natural gas, an alterna- tive cleaner fuel, would significantly reduce the emissions of greenhouse gases. However, despite the high gas potential in the country, gas explora- tion and development have been inadequate mainly due to past neglect, financ- ing constraints, and limited access to advanced technologies. Consequently, only a small portion of the potential gas resources have been exploited and natural gas accounts for only 2 percent of the commercial energy consumption in the country. 4. With an annual production of about 6.5 billion cubic meters (bcm), Sichuan Province accounts for 90 percent of nonassociated natural gas and 44 percent of all natural gas (associated and nonassociated) produced in China. The Sichuan Petroleum Administration (SPA) is the primary agency responsible for the exploration, development and transmission of natural gas in the Prov- ince. 5. SPA's gas transmission and distribution (T&D) system consists of a pipeline grid and a number of spurs (totaling about 2,800 km in length). SPA supplies about 16 thousand cubic meters (mcm) of natural gas per day to about one million households, commercial entities and small industries through 15 city gas companies and directly to about 600 large industries. Most of SPA's T&D system is 12-20 years old. Mainly due to financing constraints and inade- quate et Dnomic/financial incentives, there is a large backlog of investments require.. to rehabilitate the T&D system, which is pron( to breakdowns, acci- dents and gai leakages due to corrosion. Based on the results of a recently completed diagnostic study finaniced under UNDP's Preinvestment Facility (PRIF), the proposed GEF project would help finance priority environmental upgrades of SPA's T&D systen,.  - 2 - 6. Significant progress has recently been made in rationalizing gas pricing; since May 1, 1992, the average level of well-head prices in Sichuan has been increased by about 50 percent. However, in order to mobilize the necessary resources for sector development and to provide adequate incentives for efficient supply and consumption of gas, fu .ther improvements in both the levels and structure of gas pricing are required. In this connection, a UNDP- financed study on Sichuan gas allocation and pricing was recently completed with the assistance of an international consulting firm. Broad agreement has been reached on the stvdy's recommendations for economic principles that the Sichuan authorities would apply in the allocation and pricing of natural gas. Under the proposed Bank-assisted Sichuan Gas Development and Conservation Project (referred to from hereon as the IBRD Project), assurances have been obtained that the Government would implement the agreed reform action plan for gas pricing and allocation criteria. 7. Environmental Policy Framework. China's rapid industrial growth has been accompanied by greater concern for the environmert. The Chinese authori- ties are increasingly aware of the need to address environmental problems and recent official policy calls for economic development to proceed in tandem with environmental protection. In this connection, the Bank has been actively involved in assisting China in developing its overall environmental policies, strategies and action plans. Furthermore, several environmental operations have been developed and are under implementation with the Bank's assistance. S. During the last 10 years, China has made significant progress in environmental protection policies and programs. It has set up an institution- al and policy framework for environmental protection, established comprehen- sive and strict pollution guidelines (including a system of pollution levies and effluent fees) and, since 1984, required environmental assessments for most public investments. The State Environmental Protection Commission (SEPC), which includes the heads of all relevant ministries and agencies, and ultimately the State Council are at the apex of decisionmaking on environmen- tal policy in China. SEPC relies heavily on its secretariat, the National Environmental Protection Agency (NEPA) to oversee environmental policies and regulations. Implementation and enforcement are mainly the responsibility of the vast network of provincial, municipal and local environmental protection bureaus. Every line ministry also has an environmental department. As a result of these measures, there are indications that China has made progress in addressing its environmental problems and in reducing the rate of environ- mental degradation in some regions of the country; however, as in most coun- tries, the implementation of environmental policies and standards has not been uniform, and the impacts of economic pol.icies and very rapid growth have not always been conducive to sound environmental management. 9. China recognizes the serious consequences of global warming caused by the excessive human-induced emissions of GHGs. Relevant government depart- ments and the scientific circles in China have already engaged in extensive research in this regard. To date, preliminary analyses and evaluations have been made on the impact of global warming on China's environment. A Climate Change Coordination Group, an interagency committee of five leading governmen- tal departments, was created in February 1990, and charged with overall policy formulation on the GHG issue. NEPA, together with other ministries and agen- cies, takes a leading role in policy formulation, esiecially with respect to  -3- the impact of global climate change. In this connection, &. national strategy of GHG emissions zeduction is being developed with GEF grant support. In tandem with the development of a national policy to address global warming concerns, an institutional framework is being further developed. Irn addition, China has developed a country program, with the assistance of UNDF and the Bank, which aims at the phasing out of ozone-depleting substances (ODS). Separately, environment-related sector work recently completed by the Bank has included (a) a study of t';a efficiency and environmental impact of coal use in China (Report No. 8915-CHA), March 20, 1991; (b) an environmental strategy paper for China (Report No. 9669-CHA), April 1992; and (c) China Energy Con- servation Study (Report No. 10813-CHA), February 4, 1993. 10. IBRD Proiect Obiectives. The IBED project aims to: (a) support the implementation of the upstream oil and gas sector restructuring; (b) ratio- nalize both the levels and structure of gas pricing; (c) promote rational gas allocation; (d) reduce acute gas shortages and environmental degradation in Sichuan through increased gas production (and avoidanice of coal consumption) and energy conservation; (e) improve the efficiency cf gas production and optimize ultimate recovery of gas reserves through sound reservoir management and state-of-the-art enhanced gas recovery technology; (f) under the proposed GEF component, enhanee the safety, reliability, operational efficiency and environmental management of the gas T&D system, including the reduction of gas leakage which would, in turn, reduce methane emissions and the GHG effect; and (g) strengthen the institutional capabilities of China National Petroleum Corporation (CNPC) and SPA. 11. The project would comprise three main components: (a) a restructur- ing component, implementation of the first phase of restructuring the upstream oil and gas sector, including commercialization and corporatization of CNPC/SPA through their transformation into joint-stock companiss, introduction of a commercial accounting system and implementation of productivity enhance- ment and related human resources development programs; (b) an investment com- ponent (98 percent of project cost), including gas field development in Eas- tern Sichuan through the drilling of about 100 wells; seismic survey and interpretation; and construction of related surface facilities (62 percent); gas field stimulation and rehabilitation pf ,alut 90 wells in Eastern Sichuan and 100 wells in Central Sichuan (15 perlent); iund expansion (9 percent) as well as rehabiiitation and environmental upgrade (12 percent) of SPA's gas T&D system; and (c) an institution building component (2 percent), technical assistance and training for the implementation of the above two components as well as for national petroleum education to upgrade the teaching and research capabilities of the local petroleum institutes and develop exchange programs between the local and foreign institutes. 12. GE? Supported Actions. A PRIF-financed study evaluated the gas transmission and distribution system's integrity, efficiency and reliability and determined the most efficient measures for its rehabilitation, including measures to reduce methane emissions. The main findings of the study are summarized as follows: (a) the integrity of the system is threatened; 110 pipe failure accidents were r-ported during the past two decades. In the absence of adequate remedial measures, fuirther deterioration of the system would result in an increasingly high risk of accidents which would jeopardize the safety of the general public, disrupt gas supply to customers and increase  - 4 - GHG emissions; (b) internal corrosion in the pipelines due to release of sour gas into the transmission system is the most serious problem; (c) in emergen- cies, the grid control system cannot efficiently respond to rapid changes in the operating conditions; (d) methane losses from the overall SPA natural gas system (from gas production wells to city gate) are estimated to vary between 1.06 and 3.53 percent of throughput, which are close to the original estimate of I to 3 percent. However, the relative share of methane losses from gas production and gathering (77 percent) is significantly higher than originally anticipated. Gas distribution ( 6.7 percent), gas transmission (4.8 percent) and gas purification (1.2 percent) account for the balance of the methane emissions. Almost all of the methane emissions from the SPA gas system are due to fugitive equipment leaks; and (e) until recently, responsibility for the operation of the system was divided between several departments and there was a lack of accountability at 'the senior management level. 13. To address the above issues, a risk.-averse, least-cost rehabilita- tion program 'nas beeni formulated based on the above diagnostic study. Th- reimedial measures would include (a) installation of adequate gas treatment fAcilities, and introduction of practices to allow only dry and sweet gas (in accordance with the specifications) to enter the pipelines; (b) rehabilitation and environmental upgrading of the transmission and distribution (T&D) system to mitigate the risk of accidents and enable optimal upgrading and expansion of the system for safe and efficient operation as well as environmental pro- tection over the next 20 years; (c) enhancement of safety regulation; and (d) institution building tnrough technical assistance and training. Further, all functions relating to gas transmission and distribution have recently been consolidated into a single subunit (SPA T&D Company) which is fully account- able for efficient transportation of gas from the fields to the consumers. 14. Description of GEF Support Actions. The proposed GEF gas transmis- sion/distribution rehabilitation will be a joint effort between SPA, GEF and IBRD to eliminate gas losses and improve the gas pipeline network performance through two subcomponents to be simultaneously implemented. The first one, to be partly financed by the IBRD loan, would enhance both the safety and opera- tional efficiency of the T&D system through: (a) rehabilitation and upgrading of pipelines, measurement, corrosion control, corrosion inhiibition, telecommu- nication, gas control, gas quality monitoring and emergency response facili- ties of SPA's entire gas transmission and distribution system; (b) deteriora- tion monitoring and evaluation of the T&D system; (c) provision of a supervi- sory control and data acquisition system (SCADA) for the whole T&D system; and (d) technical assistance and training. 15. The second subcomponent, to be partly financed by the proposed GET grant, would include cost-effective measures to reduce gas leakages through a program of environmental upgrades, including: (a) installation of additional valves at the vent stacks of both the gas gathering and transmission systems; (b) installation of chained caps or plugs on open-ended pipelines; (c) upgrad- ing or replacement of the seals of control valves; (d) replacement of high performance compressor seals; (e) upgrading of the seals of block valves; and (f) the implementation of comprehensive gas leak detection and repair pro- grams, including repair or replacement of various types of valves (control valves, block valves and pressure relief valves); plugging of open-ended lines; and provision for methanc-emission monitoring equipment. The economic  values of gas saved as a result of the environmental programs would more than offset the capital and operating costs, thus yielding net economic benefits. Three of these programs (replacemenc or upgrading of the packing of block valves, replacement of control valves and plugging open-ended lines) would entail net incremental costs xwhich would be partly financed by tiu_ proposed GET grant. Further discussions of the proposed GEF component are in Annexes 1 and 2. 16. Cost and Financing. The total component cost (excluding interest durintg construction) is about $109.5 million, of which foreign exchange expen- ditures are about $73.6 million (67 percent). The proposed $10 million GET grant would finance an environmental upgrade program representing about 9 per- cent of the total project cost and 14 percent of the foreign exchange expendi- tures. The IBRD loan would finance about $53.0 million of the foreign exchange expenditu.es. SPA and CNPC would provide the remaining funds (including interest during construction of $13.2 million) consisting of $35.9 million in local currency and $23.8 million in foreign currency. 17. Implementation. SPA would be responsible for the implementation of the IBRD project and the proposed GEF component. For this purpose, SPA has *stablished a Project Management Office (PMO) to coordinate the various proj- ect activities. Implementation of the GEP component is e;pected to be com- pleted by June 30, 2000 and the Grant closing by June 30, 2001. 18. Sustainability of the Proposed GEF Actions. The Chirese authorities are fully committed to this component as it offers the opportunity of enhanc- ing the safety, efficiency and environmental protection of the natural gas T&D system in the largest gas-producing province in China. In addition, under the IBRD project, an agreement has been obtained from the government on the imple- mentation of a gas pricing reform action plan which would increase the finan- cial incentives to the gas producer to conserve gas resources, including the reduction of gas leakages. Further, the IBRD project would lend added momen- tum to enterprise reform and support the implementation of a regular gas leak detection and maintenance program and human resources development to improve the management and operational efficiency of the gas supply system, as well as reducing environmental 1mpacts and improving system safety. All these mea- sures will contribute toward the project's sustainability. 19. Lessons from Previous Bank-Financed Natural Gas Projects. Bank participation in the gas sector in China has thus far included two operations which were completed recently: Weiyuan Gas Field Technical Assistance Project (Loan 2580-CHA) and Liaodong Bay Petroleum Appraisal and Technical Assistance Project (Loan 2708-CHA). The lessons learned from these projects included (a) fragmentation of responsibilities among various Chinese agencies, coupled with cumbersome internal clearance procedures, contributed to significant delays in initial procurement activities of the Weiyuan Project--in contrast, the streamlined procurement arrangements under the Liaodong Bay Project con- tributed to the timely implementation of the project; (b) delays in the imple- mentation of institution building ccmponents could be mitigated through reach- ing agreements on the training program and the Terms of Reference for consul- tant services no later than negotiations; and (c) a strong project management unit with adequate staff to provide requisite coordination among multiple agencies is crucial for efficient project implementation.  - 6 - 20. In addition, the principal lessons indicated in "A Review of World Bank Lending for Natural Gas" (Report No. 10828) include (a) the Bank's assistance has had a significant impact on imiproving the technical capacity of gas institutions, particularly where there were twinning arrangements with an internationally experienced foreign operating company or gas utility; and (b) a major weakness of the Bank's institutional development approach was its strategy of trying to do everything at once; a more long-term view was necded, given that the goals of institutional development generally will not be achieved within the time span of one project. The design of the proposed project has built on the above lessons learned from earlier Bank operations. 21. Rationale for GET Funding. Based on the recommendations of the PRIF-financed diagnostic study, GET grant funding is proposed to finance the incremental cost o