China - Shandong Environment Project

Report No. PIC3687 Project Name China-Shandong Environment Project Region East Asia and Pacific Sector Environment Project ID CNPA40185 Borrower People's Republic of China Implementing Agency Shandong World Bank Environmental Protection Project Management Office Mr. Zhang Minghua, Director 46 Jingwu Xiaoweisi Road Jinan, China 0001 Fax: 86-531-793-9754 Date PID Updated December 20, 1996 Projected Appraisal January 1997 Projected Board Date May 1997 Country and Sector Background 1. Shandong Province has a land area of approximately 150,000 sq. km and a total population of 86 million people; it boasts the largest agricultural output amongst China's provinces. In terms of GNP and gross industrial output it holds second rank; in terms of total exports, Shandong ranks fourth. 2. The province has been one of the engines driving China's impressive economic growth over the last decade. This was primarily the result of substantial increases in agricultural productivity and industrial output. The latter took place to a large extent in Shandong's urban areas, particularly in Jinan, the capital city and in the coastal cities of Qingdao, Yantai and Weihai. As a consequence, Jinan City, for example, suffers from coal emission pollution and acid rain from its abundance of industrial and residential boilers which is exacerbated by the city's adverse topographic location with over 200 inversion days per year. Thus, in terms of air quality Jinan ranks fourth among the 37 most "environmentally stressed cities in China, constricting economic development," according to the National Environmental Protection Agency. Most other cities in the province are also failing to meet the national standards on air pollution. The situation is especially alarming during the heating season (four months of the year). 3. Shandong Province has a rain-sparse climate with a large amount of the water supply derived from underground sources. Some of these aquifers are being increasingly polluted and reduced below replenishment amounts and domestic and industrial water has to be extracted from often polluted rivers, rain-fed reservoirs or piped from distant water sources. Some cities, e.g., Jinan, Qingdao and Zibo, have to rely on costly water transmission from the Yellow River. At the same time, most rivers and lakes, especially the Xiaoqing River and the Nansihu Lake are heavily polluted, aggravating water shortages and restricting long-term  economic development. 4. Environmental Policy in Shandong. The provincial government readily acknowledges that the environmental situation in Shandong is "serious" due to its extremely fast industrial growth as result of its transition to the market economy. But it also blames historic mistakes, "backward technology" and shortage of funds. To combat further environmental deterioration, the province and the three cities who would be included in this project, have mapped out environmental policies and programs which are aimed at substantially reducing the main pollution problems by the end of this century. These efforts should on one hand permit economic growth, but on the other hand markedly reduce industrial pollution and improve municipal environmental treatment measures and provide ecological protection. Particular mention is made in these plans to regional water-shed protection as well as environmental management. Main emphasis will be given to three areas that are most environmentally stressed: the area around Lake Weishan in the South, the industrial heartland area of the Xiaoqing River Basin in the central part of the province and the northeastern peninsula area on the coast. The latter two areas are the geographical focus of this project. 5. Industrial Pollution Control. Industry is the primary source of both water and air pollution, as well as hazardous and toxic wastes, and although the amount of pollution generated per unit of industrial output has decreased over the past ten years in China generally and in Shandong specifically as a result of industrial efficiency gains, cleaner technology, and environmental regulation, the absolute level of industrial growth has swamped this relative improvement. Therefore, the national government, as well as Shandong Province and the three principal cities have made improved industrial pollution control their primary environmental target for the next five-year plan period (1996- 2000). 6. With the industrial capital stock in Shandong doubling on average every 4 or 5 years, the province has placed primary emphasis on cleaner production and technology for new industry. One of the participating cities in this project, Yantai, is the national pilot city for a cleaner production program. The Xiaoqing River Basin which includes the provincial capital city of Jinan, has also been selected by the national government as the pilot provincial river basin for a concerted clean-up program. 7. Urban Air Pollution Control and District Heating. Because of China's vast coal deposits and the paucity of natural oil and gas, aost all thermal power generation, industrial process heat, and residential heating utilize coal as their major energy source. Coal, therefore, is the major source of air pollution in China. While Chinese coal is a technically and environmentally difficult fuel, it could be burned in an economically and environmentally acceptable way, if it is done in large boilers where combustion efficiency reaches acceptable levels (>85%) and which can be equipped with pollution control equipment. Burning coal in individual stoves (efficiency <c) or small boilers (efficiency approx. 50%) leads to severe air pollution and is uneconomical due to low combustion efficiency and high labor input (See China Efficiency and Environmental Impact of Coal Use, Report No. 8915-CHA and China Energy -2 -  Conservation Study, Report No. 10813-CHA). 8. Concentrating coal burning into large units, however, requires the construction of a heat carrier system to individual consumers, i.e., district heating networks. If the consumer requires steam (industry), steam pipelines must be installed. The residential housing sector normally uses a closed loop (supply and return pipe) hot water system. A further advantage of heat production in large units can be achieved by combining heat and electricity generation (combined heat and power (CHP) co-generation). 9. In Shandong Province, where the heating season is short (only about four months), industrial heat is required in addition to residential heating to make CHP generation economically feasible (as in Weihai in this project). Alternative options would be to generate condensing power with the help of extraction-condensing turbines for the non- heating season (as in Yantai in this project) or to produce residential heat in heat only boiler (HOB) plants (as in Jinan in this project). 10. China has decided that in order to reduce atmospheric pollution and to increase efficiencies of industrial and residential stoves and boilers, it ought to accelerate and improve district heating systems. To this end, the national government and some provinces, amongst them Shandong Province, are seeking to obtain technical assistance for more advanced approaches and technologies in this area from the leading Chinese universities, and from the international community. Technically, financially and economically sound district heating systems are operated in China, in many European countries (especially in Scandinavia) and in some locations in North America. Project Objectives 11. The project is part of a phased development program of Shandong Province (SP) to improve environmental conditions and sustain urban services management. The principal objective of the project is to provide a sustainable environmental framework for the long-term economic and social development of the Province, while providing a conducive foundation for industrial growth. Specific objectives of the project are to: (a) strengthen policies, regulations and institutional arrangements for municipal water, wastewater, and district heating management, and environmental pollution control; (b) support the improvement of the waters of the Xiaoqing River Basin in order to allow the waters to be used for potable supply, industry or agriculture, as appropriate; (c) expand surface water supply to Jinan to prevent further depletion of ground water aquifers; (d) facilitate complementary sustainable investments in pollution control and municipally-provided urban environmental services; (e) reduce air pollution in Weihai and Yantai; and (f) introduce a comprehensive approach to planning, prioritization, management, and financing of urban environmental infrastructure investments. Project Description 12. The project would comprise a blend of policy and investment initiatives. The policy initiatives would support a stronger market - 3 -  orientation for municipal service financial management, and environmental management of polluting industrial enterprises. Investments would support municipal strategies for environmental recovery and sustained use of natural water resources, and would comprise the following: (a) Jinan Municipality: Water Supply Management. Investments in Jinan for surface water storage, pumping, transmission and distribution facilities to augment and improve the long-term reliability of the water supply system of the city and protect groundwater resources. Wastewater Management. Investments in wastewater collection and pumping systems in Jinan for the protection of Xiaoqing River water quality and full utilization of existing treatment facilities; (b) Weihai Municipality: Investments in municipal district heating systems in Weihai, comprising combined heat and power generation plant and facilities, distribution systems, and support services for improved air quality in the city; (c) Yantai Municipality: Investments in municipal district heating systems in Yantai, comprising peak boiler and heat generation plant and facilities, distribution systems, and support services for improved air quality in the city; (d) Environmental Pollution Control: A revolving credit subloans facility to assist selected heavily polluting small and medium-sized enterprises in the Xiaoqing River Basin, to carry out high environmental benefit and cost-effective investments for pollution abatement including waste minimization in order to comply with environmental regulations; (e) Management and Agency Strengthening and Training: Investments to support and strengthen provincial, municipal, project and financial management; construction supervision services; training in sector and utility operations; updating of city, river basin environmental management plans and feasibility studies; and future project preparation. 13. The financial, urban environment service delivery and utility management policy initiatives would concentrate on (a) operational efficiency improvements; (b) resource mobilization and cost recovery measures; (c) underpinning the long-term financial and economic sustainability of urban services; and (d) environmental pollution reduction through focused time-bound Action Plans with respect to pollution from paper and chemical industries. The management and agency strengthening and training component would enhance policies and operational experience in environmental protection and water, wastewater, and district heating management. Support for these initiatives has been grouped into a number of main composite packages for the various executing agencies, covering management and agency strengthening, financial management improvement, construction supervision and training. The component would also support provincial and sector city agencies, master planning, future project preparation, and other programs of assistance to be defined. 14. SP has prepared and updated a strategy for implementing the Management and Agency Strengthening and Training component according to an agreed schedule.. The signing of contracts with consulting firms for management and agency strengthening, financial management improvement, and construction supervision would be a condition of effectiveness. Project Cost -4-  15. The total project cost is estimated at about $215.1 million equivalent, including foreign exchange of $63.6 million. Interest during construction would require an additional $6.0 million. The proposed loan of $110.0 million, would cover about 50 percent of the project's total financing requirement. The balance would be provided as follows: 49 percent by the participating municipalities and their district heating, water and wastewater entities and 1 percent by enterprises participating in the Industrial Pollution Control component. 16. The Government of China and Shandong Province have selected LIBOR- based US dollar single currency loan terms for the project in order to facilitate management of the foreign exchange risk of their borrowings, by more closely matching the currency of their liabilities with that of their net trade flows, about 50 percent of which are US dollar denominated. The Government selected the LIBOR-based product in order to preserve the full maturity of the loan, compared to the fixed-rate option that would have resulted in a 15-year term, and judges that it can manage the interest rate risk.. Project Implementation 17. The Shandong Provincial Environment Project Office (SPPMO) was established in June 1995. The office is headed by the Deputy Director of the Shandong Urban and Rural Construction Commission who is supported, on a part-time basis, by five divisions and four deputy directors from the provincial EPB, the Finance and Planning Bureau and the Urban and Rural Construction Commission. Similar organizational structures were established also at the municipal level of the three project cities. 18. The provincial and municipal EPBs play an important role in the short- and long-term policy studies and the set-up of the two proposed environmental funds. Project Sustainability 19. According to Shandong's project proposal, the air pollution components would generate (i) save 535,000 tons of coal per year; (ii) reduce S02 discharge by 120,000 t/y; and (iii) reduce smoke and dust by 35,000 t/y. These figures will have to be recalculated after the preliminary feasibility studies are finished and placed into the context of the overall ambient air quality in the three cities. As a result of the district heating component, hundreds of individual boilers will be eliminated and thousands of residential stoves discarded. While a significant improvement in the immediate project areas is expected, the immediate and direct overall pollution impact of the project on the province will be small. However, the project aims at demonstrating to the cities of Shandong and eventually to the country that viable options of district heating using advanced designs, computerized technologies, and improved management techniques can be found and successfully implemented. 20. Shandong expects further that with the expansion and connection of the sewerage collection system to the existing wastewater treatment facility would remove 80t to 90t of COD and treat 350,000 t/d of sewage - 5-  improving the Xiaofuhe and Xiaoqing Rivers, underground reservoirs, and coastal areas of the Bohai Sea and Laizhou Bay. A river water abstraction component in Jinan would further contribute to the recovery of the aquifers in Jinan. 21. Industrial pollution control strategies would be addressed through the two revolving funds under the project which are targeted to support the province's pilot undertakings in cleaner production, as well as to support the Xiaoqing River Basin Environmental Action Plan (1994) which identifies and targets specific industrial subsectors and individual industrial plants. 22. Financial sustainability will be assured by the inclusion of appropriate tariff covenants and by institutional plans aimed at enhancing corporate governance of those organizations which will operate the district heating, water and waste water components under the project. The industrial pollution control programs in Yantai and Xiaoqing River Basin have already begun, before Bank involvement, and reflect considerable willingness or support on the part of the participating stakeholders in the project localities, necessary for environmental initiatives to "take hold". The Xiaoqing River Basin Commission was established 3 years ago and its Environmental Action Plan has been approved by the provincial government, and 3 new initiatives (comprehensive environmental plans for a river basin, pollution load quotas and fines on municipalities, and a river basin secretariat primarily staffed by EPB, rather than MWR) have received approval from the national State Council for pilot implementation. 23. Project risks fall into two basic categories: implementation risk and policy risk. On the implementation side, the record of Chinese municipalities in physical implementation under similar Bank-financed projects has been satisfactory overall. However, pollution control fund components have faced delays and, as a result, considerable efforts have been undertaken during project preparation by the two implementing agencies to evaluate the existing funds under other projects in order to design better operating procedures, and administrative and financial mechanisms into the ones proposed for this project. 24. Policy risks include: (a) possible city resistance to timely implementation of new tariff structures. Failure to implement agreed tariffs would seriously impair the performance incentives of the utilities. To mitigate this risk, tariff increases at an early date would be required; (b) institutional reform may lag the pace of investment. To mitigate this risk, cities have been encouraged to make an early transfer of assets to the new operating entities; and (c) a sustained investment program, stretching well beyond the end date of the proposed project, will be needed to completely solve the water, solid waste and air pollution problems in the project cities and Xiaoqing River Basin. Long-term, sustained efforts will be required by the Province to expand and strengthen the river basin management authority of the Xiaoqing River Basin Commission to ensure the success of the 20- year program of pollution clean-up. To encourage continued implementation of the broader program, the proposed project includes funds for further environmental planning and monitoring and sets tariff targets to help sustain future investment. - 6-  Lessons Learned from Past Operations 25. The discussion of lessons learned focuses on three areas of central concern to the present project: provision and management of urban environmental services; pollution control; and project preparation and implementation. 26. Provision and management of urban environmental services. Bank municipal management sector work (Urban Service Delivery; Finding the Right Incentives) emphasizes the need to properly assign functional responsibilities and line revenue to expenditures. In China's case, environmental services are appropriately provided at the municipal level, where a high percentage of government revenue is also captured. Recent sector work (China: Urban Environmental Service Management, Report 13073-CHA) concludes that the major failing in environmental services has been dependence on municipal budget transfer to fund services, while greater reliance on user charges would be affordable, induce resource conservation, and create a more dependable income stream. For that reason, increasing tariffs has been a major focal point of the policy dialogue in this project. This responds, too, to a major finding in the OED review of Bank water and sanitation projects (Water Supply and Sanitation Projects; The Bank Experience 1967-1989), wherein physical performance was generally good, but sustaining financial viability and overall sectoral development was less successful. 27. Pollution control. The Bank experience in pollution control includes recent projects in China, as well as in Mexico, Brazil, India, Indonesia and the Russian Federation. A review of Bank experience (Industry and Environment: Patterns in World Bank Lending) emphasizes the need for political commitment, clear standards and regulations, incentives to comply, and institutional capability to monitor and enforce standards. When industrial pollution abatement subloans are involved, the following conditions increase likelihood of success: a profitable and growing industrial sector, flexibility in choice of technology, availability of funds at close-to-market terms, and targeting on sources that can yield significant improvement in the ambient environment. The pollution abatement components draw on these lessons and those in two recent sector studies, as well as the recently completed four short-term environmental priority studies undertaken during the preparation of this project. The latter stress issues of political commitment, appropriate standards and incentives, and institutional monitoring and enforcement capabilities. This project addresses those issues through action plans to strengthen the provincial and municipal EPBs to maximize project impact beyond the direct benefits of the investments. Poverty, Environmental Aspects and Resettlement 28. No specific poverty aspects are being addressed as part of this project. Improvements in residential heating through advanced district heating systems, drinking water supply and waste water management would benefit all segments of the population in the proposed project cities. Work on the preparation of appropriate Environmental Assessment Reports (EAs) and resettlement action plans (RAPs) started in June 1995. -7 -  Because of the need to handle waste residues properly from the district heating and industrial pollution control investments, the project is rated category A for the purpose of environmental impact assessment. The Project-wide EA has been completed, approved by China's National Environmental Protection Agency (NEPA), and found to be satisfactory by the Bank. The respective RAPs were also found by the Bank to be satisfactory. Contact Point: Geoffrey Read, Task Manager EA2EM The World Bank 1818 H Street N.W. Washington D.C. 20433 Telephone: (202) 458-4078 Fax: (202) 522-1787 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. Processed by The Public Information Center week ending January 10, 1997. - 8 -