China - Fertilizer Rehabilitation and Energy Saving Project

Document of The World Bank FOR OMCIAL USE ONLY Report No. 5367-CHA STAFF APPRAISAL REPORT CHINA FERTILIZER REHABILITATION AND ENERGY SAVING PROJECT April 22, 1985 Industry Department F~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ This doeoment has a resbicted distrihbion and may be used by recipients only in the perforance of their oflicial duties. Its contents may not otherwist be disclosed without World Bank autborization.  CURRENCY EQUIVALENTS Currency Name = Renminbi Currency Unit = Yuan (Y) US$1.00 = Y 2.80 Y 1.00 = US$0.36 (As of January 1985) WEIGHTS AND MEASURES 1 hectare (ha) = 2.47 acres I metric ton (ton, t) = 1,000 kilograms or 2,205 pounds 1 kilometer (km) = 0.621 miles 1 cubic meter (m3) - 35.315 cubic feet L liter = 0.2642 US gallon 1 kilocalorie (kcal) = 3.968 British Thermal Units (BTU) 1 megawatt (mw) = 1,000 kilowatts 1 kilocalorie per kilogram (kcal/kg) = 1.80 British Thermal Units per pound 1 kilowatt (kw) = 1,000 watts GLOSSARY OF ABBREVIATIONS AN - Ammonium Nitrate LNGCC - Luzhou Natural Gas Chemical BTU - British Thermal Unit Company CCFC - Cangzhou Chemical m3 - cubic meters Fertilizer Company MCI - Ministry of Chemical Industry CFDC - China Fertilizer mg/l - milligram per liter Development Center MIWK - The M. W. Kellogg (US) CIF - Cost, Insurance and Freight mwh - megawatt hour CNCCC - China National Chemical N - Nitrogen Content in Fertilizers Construction Company NCIC - Nanjing Chemical Industry C02 - Carbon dioxide Company FOB - Free on Board Nm3 - Normal cubic meters GOC - Government of the People's p.a. - per annum Republic of China P205 - Phosphorous Pentoxide ha - hectare Content in Fertilizers HG - Humphreys & Glasgow (LTK) ppm - parts per million kcal - kilocalorie SAA - State Audit Administration kg - kilogram SO2 - Sulfur dioxide KCN - Kellogg Continental SPC - State Planning Commission (Netherlands) tpd - tons per day km - kilometer tpy - tons per year K20 - Potassium Oxide Content tpyn - tons per year of nutrients (Potash) in Fertilizers YNGCC - Yunnan Natural Gas Chemical kwh - kilowatt hour Company LCFC - Liaohe Chemical Fertilizer Company FISCAL YEAR January 1 to December 31  FOR OMCIFAL USE ONLY CHINA FERTILIZER REHABILITATION AND ENERGY SAVING PROJECT Loan and Project Summary Borrower People's Republic of China Beneficiaries: Luzhou Natural Gas Chemical Company (LNGCC) Yunnan Naturai Gas Chemical Company (YNGCC) Cangzhou Chemical Fertilizer Company (CCFC) Liaohe Chemical Fertilizer Company (LCFC) Nanjing Chemical Industry Company (NCIC) China Fertilizer Development Center (CFDC) Amount US$97.0 million equivalent Terms : 20 years, including 5 years of grace, at standard variable interest rate Relending The Government will (a) onlend US$87.0 million equivalent Terms : to the five companies as follows: LNGCC (US$40.3 million), YNGCC (US$10.1 million), CCFC (US$11.1 million), LCFC (US$8.7 million) and NCIC (US$16.8 million) for 10 years including 3 years of grace at an interest rate of 8% and a commitment charge of 0.75%; and (b) make available under its current procedures US$10.0 million equivalent to CFDC through the Ministry of Chemical Industry (MCI), at an interest rate of 3.5% p.a. and a commitment charge of 0.75% for repayment over 20 years including 5 years of grace. The companies and CFDC will bear the foreign exchange risk. Project The major objectives of the Project are to: rehabilitate, Description: modernize and save energy in selected fertilizer facilities; improve research planning in the fertilizer industry; foster the beneficiary companies' capabilities to implement projects, and manage operations and finances; and develop strategies for modernizing medium-size fertilizer plants. The Project consists of (a) rehabilitation, modernization and energy-saving modifications in the fertilizer plants of the five companies and training of their staff; (b) equipment, data processing facilities and training to strengthen the research and design capability of CFDC and its member institutes; (c) a study, to be conducted by MCI, of nitrogenous fertilizer production costs; and (d) technical assistance in international procurement. huis document has a restricted distsibution and may be used by recpients only in the performance of their offiial duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - The Project will lead to significant savings in specific energy consumption, increase production of urea by 129,000 tpy, ammonium nitrate by 24,000 tpy, methanol by 29,000 tpy, surplus ammonia for sale by 14,000 tpy, and replace production of about 180,000 tpy of sulfuric acid. Over its economic life, the Project will generate a net foreign exchange saving of US$694 million in January 1985 US dollars. Technical risks are moderate as the project investments will be in existing plants using commercially proven technologies. The main risks of the Project are possible delays in procurement and implementation. These should, however, be minimized by the provision of consultancy services for procurement and of experienced engineering firms for project implementation. The companies are financially sound and adequate measures are provided for in the Project to maintain such soundness. Estimated Cost: Local a/ Foreign Total US$ million equivalent Rehabilitation, Energy Saving and Trainingb/ LNGCC - Luzhou 11.9 32.5 44.4 YNGCC - Yunnan 4.4 10.1 14.5 CCFC - Cangzhoui 4.2 8.9 13.1 LCFC - Liaohe 4.4 8.3 12.7 NCIC - Nanjing 24.7 20.7 45.4 Subtotal 49.6 80.5 130.1 Fertilizer R&D (CFDC) 0.7 8.9 9.6 Base Cost 50.3 89.4 139.7 Physical Contingencyc/ 5.0 7.2 12.2 Price Contingency 7.9 13.7 21.6 Incremental Working Capital 0.3 - 0.3 Total Project Cost 63.5 110.3 173.8 Interest During Construction 0.6 12.4 13.0 Total Financing Required 64.1 122.7 186.8 a/ Including taxes of US$2.0 million on equipment and material procured locally. b/ Including US$0.5 million base cost of technical assistance in international procurement, which is distributed proportionally among the five companies. c/ Physical contingencies for the fertilizer R&D (CFDC) component are included in base cost.  - iii - Financing Plan: Local Foreign Total - --US$ milion--- IBRD - 97.0 97.0 Domestic Bank loans 21.2 1.6 22.8 Beneficiary Companies 42.1 24.1 66.2 CFDC 0.8 - 0.8 Total 64.1 122.7 186.8 E stimated Disbursements: Bank FY 1986 1987 1988 1989 -----US$ million-- - Annual: 13.0 39.0 40.0 5.0 Cumulative: 13.0 52.0 92.0 97.0 Economic Rate of Return: 31 Z.  - iv - CHINA FERTILIZER REHABILITATION AND ENERGY SAVING PROJECT TABLE OF CONTENTS Page No. 1. INTRODUCTION ........... ............................. 1 II. THE CHINESE FERTILIZER SECTOR .................... . .... ...... 1 A. Fertilizer Use in Agriculture .... ..................... 1 B. Fertilizer Demand and Supply ........... ............... 2 C. Energy Consumption ........... ......................... 5 D. Fertilizer Pricing ... ....... .................. *.....* 6 E. Fertilizer Allocation System ................ .......... 8 F. Government Strategy in the Fertilizer Sector .......... 9 G. Bank Role in the Sector and Project Justification ..... 10 III. THE PROJECT BENEFICIARIES ................... *........... .g. 10 IV. THE PROJECT .............................. ............. 13 A. Project Objectives ................ .. ........... 13 B. Project Description .. .........o................ ........ 13 1. Plant Rehabilitation and Energy Saving Component ...................................................... 14 2. Fertilizer Research and Development (CFDC) Component ....... . ...................... ....... 15 3. Technical Assistance to MCI Component .. .......... 16 4. Nitrogenous Fertilizer Production Cost Study 16 C. Raw Materials and Utilities ........................... 16 D. Environmental Aspects ..* .... ... ........... ...... ........ 17 V. PROJECT MANAGENENT AND EXECUTION ........................... 18 A. Engineering Arrangements .............................. 18 B. Project Management and Status ......................... 19 C. Implementation Schedule . ......... .......... ... ... ... .. 19 D. Training ... a .... ................... ee-eeoo. 20 This report was prepared by Messrs. S.K. Agarval, L. Borin, K. Song and N. Nizam of the Industry Department. Mesdames E. George, M. Greaves and A. Johnson provided word processing assistance, and secretarial support was provided by S. Rajput, I. Haidara, M. Govoni and E. Kelly in preparation of the Report.  Page No. VI. CAPITAL COST, FINANCING PLAN, PROCUREMENT AND DISBURSEMENT . 20 A. Project Capital Cost . ................................ . 20 B. Financing Plan ......... .. ...O..... ..... ...... ... * ... * * ..... 22 C. Procurement ............ .. . ...................... ............*... 24 U. Allocation and Disbursement of Bank Loan ............... 26 VII. FINANCIAL ANALYSIS .......... . . .. . . .. . ..................... .... ... ... 27 A. Background on Financial Management Practices ..o....... 27 B. Past Financial Performance and Financial Projections .. 28 C. Financial Rate of Return and Sensitivity Analysis ..... 30 D. Financial Covenants .................. ..... 31 E. Auditing and Reporting Requirements ................... 32 F. Risks ......................................................... 33 VIII. ECONOMIC ANALYSIS .......... . .. . . .............................. ... ......... 33 A. Introduction .............. ---. ------------- ......... .................... 33 B. Economic Costs and Benefits ........................... 34 C. Economic Rate of Return .....*.-we**** .......... *......... 35 D. Sectoral Contributions and Other Benefits .............. 37 IX. AGREEMENTS AND UNDERSTANDINGS REACHED AND RECOMMENDATIONS ..... 38 ANNEXES 2-1 Historical Consumption, Production and Imports of Fertilizers, 1972-1983 2-2 The Fertilizer Industry 2-3 Comparison of Domestic and International Prices of Fertilizers and Main Erirgy Inputs, January 1985 3 Project Beneficiaries 4-1 Plant Rehabilitation and Energy Saving Component - Project Scope 4-2 Plant Rehabilitation and Energy Saving Component - Main Project Benefits at Stabilized Production 4-3 Nitrogenous Fertilizer Production Cost Study - An Outline 4-4 Raw Materials Supply 4-5 Level of Pollution from Plant Effluents, Before and After the Project 5-1 Organization Chart of the MCI Project Implementation Coordination Unit 5-2 Project Implementation Schedule  - vi - ANNEXES contd. 6-1 Capital Cost Estimate 6-2 Estimated Disbursement Schedule for Bank Loan 7-1 Assumptions for Financial Analysis 7-2 LNGCC - Historical and Projected Financial Statements 7-3 YNGCC - Historical and Projected Financial Statements 7-4 CCFC - Historical and Projected Financial Statements 7-5 LCFC - Historical and Projected Financial Statements 7-6 NCIC - Historical and Projected Financial Statements for the Nitrogenous Fertilizer Plant 7-7 NCIC - Consolidated Historical and Projected Financial Statements for the Company 7-8 Incremental Cost and Revenue Streams for Financial Rate of Return Calculations 7-9 Definition of Efficient Plant Operation 8-1 Assumptions Used in Economic Analysis 8-2 Incremental Cost and Revenue Streams for Economic Rate of Return Calculations 8-3 Foreign Exchange Savings 9 Selected Documents and Data Available in the Project File MAP IBRD No. 18561 China - Major Fertilizer Plants and Fertilizer Research and Design Institutes  CHINA - FERTILIZER REHABILITATION AND ENERGY SAVING PROJECT I. INTRODUCTION 1.01 The Government of the People's Republic of China (the Government, GOC) has requested a Bank loan of US$97.0 million equivalent to finance the Fertilizer Rehabilitation and Energy Saving Project (the Project). The Project aims at meeting two of the Government's major objectives concerniing the industrial sector, namely (a) modernization of existing enterprises particularly through adoption of new technology; and (b) industrial energy conservation. The Project also aims at improving research and design capabilities in the fertilizer sector. 1.02 The Project consists of four components: (a) rehabilitation and energy saving modifications in the operating fertilizer plants of the five companies (Map IBRD 18561) located at Luzhou, Shuifu (Yunnan plant), Cangzhou, Liaohe and Nanjing (the Plant Rehabilitation and Energy Saving Component); (b) support for fertilizer research and development to the China Fertilizer Development Center (CFDC) and eight fertilizer research and design institutes affiliated to CFDC (the Fertilizer Research and Development (CFDC) Component); (c) technical assistance for the project implementation coordination unit in the Ministry of Chemical Industry (MCI) (the Technical Assistance to MCI Component); and (d) nitrogenous fertilizer production cost study. The Project will require total financing, including physical and price contingencies and interest during construction, of about US$186.8 million, with US$122.7 million in foreign exchange. The proposed Bank loan of US$97.0 million will cover 52.5% of the total financing (net of taxes) and 79.1% of the total foreign exchange required. 1.03 The Project was appraised in July/August 1984 and January 1985 by Messrs. S. Agarwal (Mission Chief), L. Borin, K. Song and N. Nizam (Industry Department), S. Salman (Legal Department) and Mr. W. Fox (Consultant). II. THE CHINESE FERTILIZER SECTOR A. Fertilizer Use in Agriculture 2.01 Improved irrigation, better crop varieties and higher levels of chemical fertilizer use have been the most important material inputs behind China's good agricultural performance in recent years. Foodgrain production dominates the Chinese agriculture and accounts for some 65% of the total agricultural output and 80% of its cropland. Between 1952 and 1983, foodgrain output increased at an average annual rate of 2.8% or from 164 million tons per year (tpy) to 387 million tpy. Despite the country's vast land area of about 960 million ha, only about 100 million ha or 10.4% of the total are arable. About 45 million ha of the total arable area are irrigated. China accounts for less than 8% of the world's arable land but  -2- supports about 22% of the world's population. Applfcation rates for chemical fertilizer almost doubled between 1978 and 1983 and, by 1983, averaged about 115 kg of nutrients per sown ha. About 70% of available fertilizer is used on grains and 30% on other crops. Consumption annual growth rate of 13% on average for chemical fertilizer during 1972-1983 is among the fastest registered for any developing country over a similar period of time. Current application levels are more than three times those in India, about equal to levels in the US and a third of those in Japan or South Korea. 2.02 Fertilizer use in Clina has been stimulated by greater availability (from both increased domestic production and higher imports) and improvements in the level and structure of agricultural prices growing out of the 1979 price reforms. The nutrients ratio of nitrogen: phosphate: potash (N:P:K) for China (1983) of 100:32:5 compares unfavorably with the world average of about 100:51:37. This serious nutrient imbalance in China, i.e., low application of phosphate and potash reduces synergism and the benefits from the relatively high levels of nitrogen use. There are also disparities in fertilizer use among provinces with a range of 50 kg to 170 kg of nutrients per sown ha. Out of about 100 million ha of China's cultivated land, only about a quarter is classified as high and stable yield areas, another 40 million ha are medium yield and about one-third is considered low-yielding areas. Fertilizer will obviously continue to be a major factor contributing to future agricultural growth within an environment of unchanged cultivated area. The question is whether inability to increase supplies especially of phosphate and potash fertilizers rapidly enough can be anticipated to be a major constraint on growth (para 2.10). B. Fertilizer Demand and Supply 2.03 Historical production, consumption and imports of chemical fertilizers in China for the period 1972 to 1983 are given in Annex 2-1 and are summarized in the table on the following page.  - -~~~~~~~~~~~3- China - Fertillizer Consumptions/; Production and Impoits Past and Projected (in thousand tons of nutrient) Nitrogn 04) Phosphate (C:k) t sbcash 0CKO) Total Nbtriert Cbns. Prod. Duo. CO. Prod. M. bD. Prod. Imp. CDS. Prod. MN 1972 3,168 2,444 1,402 1,039 1,249 12 10 8 5 4,217 3,701 1,419 1980 10,284 9,993 1,537 2,410 2,307 395 128 20 126 12,822 12,32D 2.058 1982 10,430 10,219 1,430 3,400 2,537 648 570 25 545 14,400 12,781 2,623 1983 11,927 11,094 1,862 3,803 2,666 955 584 29 355 16,314 13,789 3,372 1990 (proj.) h. 13,000 13,000 - 6,100 4,000 2,100 2,300 100 2,200 21,400 17,100 4,300 Average Anial Gwwth Rates (%) 1972-1980 15.9 19.2 11.1 8.0 37.5 12.1 14.9 16.2 198D-1982 0.7 1.1 18.8 4.9 111.0 11.8 6.0 1.8 1982-1983 14.4 8.6 11.8 5.1 2.5 16.0 13.3 7.9 1983-1990 (proj.) 1.2 2.3 7.0 6.0 21.6 19.3 4.0 3.1 a/ Sals to farmers. bl Projected imports for 1990 are for gs in domstic production ard sales to farnmrs. Souce: MM, M4nistry of Agricuature, Aniul Hwsbandy snd Fishery ad axmion estliutes. 2.04 Fertilizer Demand. Consumption of all fertilizers increased from 4.2 million tons per year of nutrlents (tpyn) in 1972 to about 16.3 million tpyn In 1983, at an annual average rate of 13% per annum (p.a.). Of the total consumption in 1983, 73% was nitrogen, 23% phosphate and 4% potash. Nitrogen consumption grew at an annual average rate of 16Z during 1972 - 1980, but remained static during the 1980-82 period due principally to the Government's emphasis on encouraging the consumption of phosphate and potash fertilizers to improve overall nutrient balance, and very little increase in domestic nitrogen production In that period. Nitrogen consumption In 1983 was significantly higher by 14.42 due to Increased nitrogen production. Phosphate consumption, after Increasing at an annual average rate of 11% during 1972-1980, grew further at 19% p.a. during 1980-1982 but slowed to 12% in 1983. Potash consumption, except in 1983, has grown at a much faster rate during the last decade due to the negligible base in the early 1970s. China also has a long history of using organic fertilizers and, until very recently, organics probably supplied a major share (about 50%) of total nutrients from fertilizers, and continue to be important sources of nutrients particularly for P, K and some trace elements. 2.05 Although the Seventh Five-Year Plan (1986-1990) is still being finalized, the Ministry of Agriculture, Animal Husbandry and Fishery expects the chemical fertilizer demand to grow at an annual average rate of 4% to about 21.4 million tpyn by 1990. If, as the Government envisages, the N:P:K nutrients ratio of about 100:50:20 were to be achieved compared with 100:32:5 in 1983, consumption in 1990 would consist of about 13 million tons of N, 6.1 million tons of P205 and 2.3 million tons of K20. This would correspond to a very low growth rate of 1.2% p.a. in nitrogen consumption due to the already high nitrogen application levels.  - 4 - The high forecast growth in potash consumption (22% p.a. during 1983-1990), while desirable and necessary for improved nutrient balance, appears optimistic, especially in view of the large gap between consumption and domestic production that would be involved (about 2.2 million tons of nutrient in 1990). Phosphate consumption will have to increase at an annual average rate of 7%, which is also an optimistic target. In any event, it is expected that the nitrogenous fertilizer demand will increase at a low pace, whereas demand for phosphate and potash fertilizers will increase at a muc1i faster rate. 2.06 Fertilizer Production. China is the world's third largest producer of chemical fertilizers after USSR and USA. Chemical fertilizer production in China has increased from 3.7 million tpyn in i972 to 13.8 million tpyn in 1983 from some 2,000 plants, with a wide range of production technologies and sizes. Most of the plants are of very small size and with outdated technologies. The substantial nitrogen capacity, built over the last 30 years, includes some 1,200 small plants (5,000-60,000 tpy ammonia capacity), about 55 medium-size plants (60,000-150,000 tpy ammonia capacity), and 13 large ammonia/urea plants built in the 1970s with foreign know-how and substantially imported plant and equipment, each of about 281,000-330,000 tpy of ammonia and 535,000-575,000 tpy of urea capacity. One more indigenously built large plant has a capacity of 330,000 tpy ammonia and 267,000 tpy urea, marketing the surplus ammonia for industrial use. The small-, medium- and large-size nitrogen fertilizer plants account for about 60%, 17% and 23%, respectively, of total nitrogen fertilizer production. This evolution reflects mainly the technologies available at the time of plant construction and China's decision during the early phase of the development of the fertilizer industry to rely on indigenous technology to the extent possible. The average capacity utilization for the 13 large nitrogen plants in 1983 was 81%, with five plants operating below 80% capacity due to constraints in feedstock supplies (natural gas and naphtha). The operation of the only indigenously built large nitrogen plant has so far suffered due to technical problems. Except for 8 plants each with capacity exceeding 200,000 tpy of low grade Phosphate fertilizers, the phosphate capacity consists of a large number of plants (about 700) with capacity ranging mainly between 10,000 and 100,000 tpy of low grade products. China has only one small potash fertilizer plant. Domestic fertilizer production in China is characterized by a small number of product types and low average nutrient content. In the case of nitrogen fertilizer, about 58% of the production is ammonium bicarbonate with 17.5% N. Main features of China's fertilizer industry, i.e., types of fertilizer products, feedstock for nitrogenous fertilizers, plant capacity and technologies, and energy consumption levels for ammonia production are summarized in Annex 2-2. 2.07 Nitrogenous fertilizer production grew rapidly (19.2% p.a.) during 1972 to 1980 when the large ammonia/urea plants were built and commissioned. During 1980-1982, little new capacity was added. Again in 1983, production increased by about 9% mainly from the small- and medium- size plants. Phosphate fertilizer production picked up only in the 1960s and increased at an annual average growth rate of 8% during 1972-1980 but  -5 slowed during 1980-83. Production of potash fertilizer began only in the 1970s. 2.08 The Government has targeted for total nutrient production by 1990 of about 17.1 million tons, of which 13 million tons are for nitrogen, 4 million tons phosphate and 0.1 million tons potassium fertilizers. This implies a modest growth of 2.3% p.a. for nitrogen. The targeted phosphate fertilizer outpu. envisages about 6% p.a. growth which may not be easy to achieve. Pbtash output is projected to more than triple by 1990 but will still remain very small. 2.09 Out of the four large nitrogenous fertilizer plants based on residue oil and coal, which have been under construction with initial delays in 1980 and 1981 due to domestic financial constraints, one was completed in late 1984. The second plant is scheduled for completion in mid-1985 and the remaining two plants are to be completed by 1987. Present plans for additional phosphate fertilizer production include six plants (including a joint venture project with Kuwait and Tunisia) with a total capacity of 200,000 tpy of triple superphosphate, 280,000 tpy of nitrophosphates, and 960,000 tpy of diammonium phosphate. The above capacity additions for phosphate fertilizers will be inadequate to meet China's fertilizer needs up to 1990. 2.10 Fertilizer Denand and Supply Balance. About 852 of China's total consumption of chemical fertilizers in 1983 was produced domestically (93% for nitrogen, 70% for phosphate and 5% for potash). Despite the impressive build up in production capacity during the last decade, fertilizer imports, in 1983, were 3.4 million nutrient tons and have averaged about 2.5 million tpyn in recent years, at a value over US$l billion p.a. making Cina one of the world's largest importers of fertilizers. While domestic nitrogen production and consumption are expected to be about in balance by 1990, deficits of phosphate and potash fertilizer will substantially increase. The gap between domestic production and consumption - to be met by imports, is expected to increase from 2.5 million tpyn in 1983 to about 4.3 million tpyn in 1990, or from 15% to about 20% of requirements plus provision to cover fertilizer in transit, stocks and distribution losses. C. Energy Consumption 2.11 Generally energy consumption in China's nitrogenous fertilizer plants is higher than today's levels for modern plants by about 11-16% for large-scale, 26-30% for medium-size, and 17-25% for small-size plants (Annex 2-2). The large plants were built in the 1970s and, therefore, do not incorporate the technological improvements now available to minimize energy consumption. Substantial possibilities also exist for energy saving in the 55 medium-size plants, which require substantial process modifications in view of their age and obsolete technology. The small-size nitrogen plants (about 1,200 in total) consume about 46% more energy compared with the more efficient anthracite/coke based medium-size plants now being designed. Given the age, obsolete technology and broad range of process configuration of the small plants, the most appropriate energy efficiency measures are limited to better management and maintenance.  -6- 2.12 The problem of high energy consumption in fertilizer industry can be solved only gradually as it requires substantial capital investment in technical renovation and some restructuring of the industry. The Government has assigned high priority to technical rehabilitation of and energy efficiency improvements in the fertilizer plants, and has adopted a number of policy measures--both administrative and price incentives, to improve industrial energy efficiency. Cutbacks in planned allocations of energy to major industrial users appear to have been the most frequently applied measures thus far. Energy consumption norms have been gradually reduced and more strictly applied. When an enterprise succeeds in reducing its energy consumption below the quota, bonuses are paid, but if the enterprise cannot lower energy consumption to the quota limit, it cau bbuy additional energy, if available, only at higher prices. Some very inefficient plants have been closed down. Fifty-five energy conservation centers have been established throughout the country to provide industrial enterprises with technical assistance in improving energy efficiency. The Government has also recently introduced some price increases such as for natural gas and coal including increased taxation on petroleum fuels to encourage both conservation and fuel substitution. The present energy prices (para 2.16) are, however, not fully conducive to energy conservation. Appropriate reform of the price system especially of energy prices, complemented with improvements in the effectiveness of the remaining administrative measures, should provide further incentives for more rational and efficient energy consumption. D. Fertilizer Pricing 2.13 Both ex-factory and farmgate prices of fertilizers, like for other essential commodities in China, are administered by the National Comm-dities Price Bureau, which functions as an independent entity under the supervision and guidance of the State Council. Ex-factory prices of urea and ammonium nitrate (AN), produced by the nationally and provincially managed fertilizer plants, are uniform throughout China. Ex-factory prices of other nitrogen fertilizers mainly ammonium bicarbonate, produced by small-size plants which are managed by county governments, communes and production brigades, are administered by the county governments; they are given some freedom to vary them from the n&-ionally recommended levels depending on local conditions. The ex-factory prices of trrea and AN, which had remained unchanged since mid-1970s, were increased in February 1984, from Y 350/ton (US$125) to Y 400/ton (US$143) or by 14% in the case of bagged urea, and from Y 220/ton (US$79) to Y 270/ton (US$96) or by 22% for bagged AN. These increases were to cover the increase in raw materials' prices and to reflect consumer preferences. The ex-factory price of ammonium bicarbonate generally ranges between Y 130 and Y 150/ton (US$46-54). The ex-factory prices of urea and AN and the delivered prices of main energy inputs . January 1985, along with their international prices are given in Annex 2-3. 2.14 Ex-factory fertilizer prices in China (January 1985) are 77% for urev. and 59Z for fertilizer grade AN of the FOB international prices. On the basis of landed prices at Shanghai, they amount to LIZ and 48% for urea and fertilizer grade AN, respectively. DDmeitic prices are thus lower than international prices, principally because energy input Prices in China are also lower than economic prices. Domestic relative prices of fertilizers and energy inputs are, however, in line with international relative prices  (para 2.16). The Government's policy on ex-factory fertilizer pricing is to cover on average full production costs and provide a profit margin of about 17% after product tax on sales. Fertilizer prices in the past have provided satisfactory financial returns on investments. 2.15 While prices currently play only a limited role in resource allocation and consumer decisions, the Government has become increasingly aware that without overall price reforms and an increased role for market forces, efforts to revitalize enterprise planning and management through financial reforms cannot succeed. The two main elements of the Government's October 1984 decision to reform the economic structure thus relate to overall price reforms and a decrease in the Government's direct control of the economy. However, due to its importance in the national economy, fertilizer production will continue to be planned by the Government and its prices will remain administered. 2.16 Price reforms are of particular importance in the fertilizer sector as ex-factory prices should reflect adjustments in the pricing of energy-a major input for fertilizer production. The Government is keenly aware of the need for rationalization of energy prices, and this is an important element of the Bank's ongoing economic dialogue with the Government. In 1984, gas prices for fertilizer production were increased by 43% for the Luzhou and Yunnan plants, and by 74% for the Cangzhou plant, and in early 1985 by 64% for the Liaohe plant. Coal prices for the Nanjing plant were also increased by 18% in 1984. Nevertheless, current natural gas prices for the four gas-based fertilizer plants under the Project are on average about 60% of the economic value of fuel oil equivalent in calorific terms. Similarly, the price of anthracite for the Nanjing plant is about 60% of its economic value. Large increases in domestic energy prices resulting from rationalization of the energy pricing structure would alter relative prices between fertilizer and energy inputs, and also have a noticeable impact on the financial viability of nitrogen producing companies. However, in line with the Government's October.1984 decision on economic reforms, the adjustment in fertilizer prices to offset increased energy prices will be only partial as the plants will be expected to increase their efficiency and reduce energy consumption. The Government considers the proposed Project as a model to prepare industrial enterprises for the new incentive regime of the price structure by improving their energy efficiency and minimizing production costs. 2.17 Farmgate prices of fertilizers have also not changed during the last decade except in February 1984 when the prices of urea and AN were increased by about 13% and 16%, respectively, following an increase in their ex-factory prices. The farmgate urea price at Y 510/ton (US$182/ton) is 78% of the present import CIF price of about US$233/ton. The farmgate price of AN at Y 360/ton (US$129/ton) is 64% of the present CIF price of about US$202/ton. Farmgate nitrogen fertilizer price relative to the price of wheat is in line with international levels. The present farmgate fertilizer prices are higher than ex-factory prices and margins are adequate on the average to cover marketing and distribution costs. It is expected that as ex-factory prices are adjusted to reflect economic energy input prices, farmgate fertilizer prices will also be adjusted accordingly.  - 8- E. Fertilizer Allocation System 2.18 The state system of allocating fertilizer has been used as a policy instrument co encourage production and marketing of key agricultural commodities (food grains). Allocation process in the past has favored foodcrops, the high, stable yield and irrigated areas and state farms, and fertilizer supplies typically go to intensively cultivated areas where application rates and yields are high. Marginal yield responses in some high yield areas are reported to have declined from 15-25 kg of grain per kg of nitrogen in the 1960s to 5-10 kg of grain today. As a result, the Government is becoming increasingly aware that the present fertilizer allocation system, which may have been economically rational when nitrogen fertilizer application rates were low, is much less efficient due to declining marginal yield responses to nitrogen application. To correct this problem, the Government plans to allocate in the future a higher proportion of the incremental fertilizer production to crops and production zones outside the high, stable yield areas, where marginal yield responses to fertilizer application are expected to be higher. The Bank is pursuing the dialogue on this aspect with the Government in the context of its agricultural sector work and agricultural lending operations. 2.19 There is also a need to increase application of phosphate and potash relative to nitrogen to achieve higher responses in the high yielding localities, which accounted for a large portion of the increase in fertilizer consumption in recent years. Under the recent -production responsibility system" of contracting responsibilities to households or other production groups, the farmers have now become more responsive to the relative costs and benefits of various inputs and can be expected to favor in the future the increased use of phosphate and potash, and fertilizer application in areas where marginal returns are higher. 2.20 Farm sales of chemical fertilizer, in accordance with the national fertilizer allocation plan, are made by the Agricultural Means of Production Corporation, a state-owned company of the Ministry of Commerce through an extensive network of wholesale offices and retail shops. The China National Chemicals Import and Export Corporation is responsible for most imports of fertilizers, which are then distributed by the Agricultural Means of Production Corporation. Fertilizer is usually transported directly from the plants to a network of warehouses close to the consuming areas to minimize transport and handling costs. In the past, with general scarcity of chemical fertilizers and only nitrogenous fertilizers to distribute, a system of rationed distribution was easier to administer and could serve efficiency objectives. Today, with more abundant nitrogen but continuing scarcities of phosphate and potash, there is strong reason to allow the market to play a large role in allocating fertilizers. The most critical task for the Government is to develop fertilizer testing programs and related extension network, involving both economic and technical considerations, which could guide the processes of fertilizer production, distribution and utilization. Priorities for fertilizer imports should be closely aligned with the nutrient needs established by research.  -9- F. Government Strategy in the Fertilizer Sector 2.21 The three main elements of the Government's priorities in the fertilizer sector are: (a) in nitrogen, rehabilitation and energy saving in existing capacity; (b) in phosphate, rapid capacity expansion based on locally available rock phosphate; and (c) in potash fertilizers, identification and development of domestic resources. For nitrogenous fertilizer, the Government's strategy is to undertake programs to improve efficiency of the existing plants especially of the large- and medium-size nitrogen fertilizer plants, through energy efficiency measures and technical rehabilitation. Energy conservation is an important element of the Government's efforts to ease the problem of energy shortages which poses a severe constraint to China's future economic growth. Since most of the existing plants are old and do not benefit from recent developments in technology and energy saving measures, there is very large potential for improvements in this area. There are also plans to convert some of the existing ammonium bicarbonate medium-size plants to produce high nutrient fertilizers. The Government's plans are to use the rehabilitation and energy saving measures under the Project as a model in developing and implementing similar investments in other large- and medium-size fertilizer plants. Energy consumption of small-size nitrogen fertilizer plants is also very high, which mainly produce low nutrient ammonium bicarbonate. The Government recognizes that they are less economic and has recently closed about 300 such plants. There are no plans to build new small-size plants in the future. While more plants can be expected to be closed, considering the large country size and that they make use of local raw materials and serve a market area within a radius of about 25 km from the plants, the Chinese small nitrogen plants will continue to have an important role to play for some time in the future. Their efficiency is being improved through retrofitting and some increase in capacity where economically feasible. While no significant new nitrogen capacity has yet been planned, large nitrogen fertilizer plants can be built based on recent natural gas finds, especially south of Hainan Island in the South China Sea for both domestic consumption and exports (Annex 2-2). 2.22 China's low application levels of phosphate and potash fertilizers will have to be substantially increased in order to improve crop response and increase agriculture production. Despite the large raw material availability in China and the present relatively low consumption, local production capacity of phosphate and potash fertilizers is totally insufficient to meet demand. The Government's strategy is to rapidly expand phosphate fertilizer production capacity based on phosphate reserves which have yet to be fully exploited due to difficulties in both mining and processing and the need for substantial infrastructure. The Bank is financing technical assistance under the IDA-financed Technical Cooperation Credit (1412-CHA) for testing of phosphate rock and necessary feasibility studies for preparing a phosphate mine project. There is, however, need to optimize investments in the subsector by linking exploitation of phosphate rock mines to the development of the phosphate fertilizer manufacturing capacity based on integrated development including minimization of transportation costs. The Bank has proposed to the Government an outline of a phosphate subsector investment planning study and has offered to finance assistance for it under the Technical Cooperation Credit. Domestic  - 10 - deposits of potash are limited to the Qarhan Lake in the Qinghai Province, where a one million tpy potassium chloride plant is planned for eventual construction, and will be adequate to satisfy about one-fourth of China's needs for potash fertilizer up to 2000. In the foreseeable future, China is expected to continue to import large quantities of phosphate and potash fertilizers. G. Bank Role in the Sector and Project Justification 2.23 The Bank's major objectives in the fertilizer sector are to support the Government's efforts toward (a) technical renovation and energy saving measures in nitrogen fertilizer; (b) improvements in the nutrient balance through capacity expansion in the phosphate ferti.Azer subsector; and (c) institution building and training. The proposed Project would be a first step in furthering these objectives. The technical rehabilitation and energy saving component has been designed to provide experience to China which will permit it to formulate and implement similar programs for other ammonia plants. The Bank has played a major role in project design in working with the Chinese officials in the optimization of the rehabilitation component using economic analysis, and in institution building by ensuring close involvement of MCI, the project entities and design institutes in project preparation and appraisal. The Bank has also assisted in defining the scope of CFDC's activities in research and design for the fertilizer industry. Bank participation will contribute to improved financial managemenl of the conpanies through their use of appropriate financial performance criteria and strengthen capabilities in project implementation and plan; operations. The outcome of the fertilizer production cost study will help provide a basis for formulating strategies to modernize medium-size nitrogen fertilizer plants. The Government has also requested Bank assistance for a phosphate mine project. Continued Bank assistance for fertilizer development will be necessary and is justified considering the critical link between the fertilizer and agriculture sectors, and the large needs of China's fertilizer industry for technical renovation and energy saving investments and for development of the phosphate fertilizer subsector. III. THE PROJECT BENEFICIARIES 3.01 The Project involves five chemical fertilizer companies: Luzhou Natural Gas Chemical Company (LNGCC), Yunnan Natural Gas Chemical Company (YNGCC), Cangzhou Chemical Fertilizer Company (CCFC), Liaohe Chemical Fertilizer Company (LCFC), and Nanjing Chemical Industry Company (NCIC). They are state-owned industrial enterprises under the supervision of the Ministry of Chemical industry (MCI) and their respective provincial governments, and operate as distinct legal and independent accounting entities. The four fertilizer complexes owned by LNGCC, YNGCC, CCFC and LCFC are among the 13 large ammonia/urea complexes built in the 1970s with foreign know-how and substantially imported equipment. In addition, the Project involves the China Fertilizer Development Center (CFDC) and CFDC's eight member fertilizer research and design institutes, which are also state-owned and operate under the jurisdiction of MCI.  - 11 - 3.02 The five fertilizer companies, similar to all state-owned industrial enterprises, have been constrained in the past in both managerial and financial autonomy, specifically: (a) their annual production targets are set by MCI taking into account targets fixed for the fertilizer sector by the State Planning Commission (SPC); (b) major inputs are allocated from designated sources at pre-determined prices; (c) outputs are marketed as directed and at prices administered by the Government; and (d) investment plans and budgets are approved by SPC, MCI and respective provincial governments. As part of the on-going economic reforms, the Government has recently begun to introduce changes in the planning and financial regulations to provide more autonomy to industrial enterprises mainly to encourage better operational and financial efficiency. While the fertilizer sector, due to its Importance in the national economy, will continue to be planned by the L,overnment, on-going reforms in the financial regulations (tax system, remittances to the Government, profit retention, etc.) would provide increased freedom to the management of the five companies and incentives to improve their operational efficiency (para 7.03). 3.03 Detailed description of the existing plant facilities, the recent trend of production and capacity utilization of the five companies, and of their organization and management is given in Annex 3. The organization charts of the five companies and CFDC are given in Project File. The management and staff of LNGCC, YNGCC, CCFC, LCFC, NCIC and CFDC are competent and able to implement the Project efficiently. Chapter VII reviews the financial performance of the companies. A brief description of the companies' existing facilities and of CFDC is given below. 3.04 The Luzhou Natural Gas Chemical Company (LNGCC) has two ammonia/urea plants. The medium-size plant, commissioned in 1966 (the old plant), has a capacity of 300 tons per day (tpd) ammonia and 500 tpd urea. The large plant, commissioned in 1977 (the new plant), has a capacity of 1,000 tpd ammonia and 1,620 tpd urea. Since its start-up, the large plant has operated satisfactorily at about 90% capacity utilization. There is, however, scope for reducing energy consumption for ammonia production by about 8%, and for improving recovery of urea while reducing pollution (para 4.03(i)). The medium-size plant has been in operation for nearly 20 years and as a result can benefit from rehabilitation measures. Since it is based on technology of the early 1960s, the energy consumption per ton of ammonia and steam consumption in the urea plant are high. Because of the technical problems and shortage of natural gas from the Sichuan gas network, the old ammonia plant has been able to operate only at about 80B capacity during the last four years except in 1982 when capacity utilization was about 50% due to technical problems. Energy saving from modifications in both the old and new plants under the Project will make available gas savings that would permit 50% capacity expansion of the old plant while maintaining overall natural gas consumption substantially at present levels (Annex 4-4). 3.05 The Yunnan Natural Gas Chemical Company (YNGCC) has four plants: ammonia (1,000 tpd capacity), urea (1,620 tpd), nitric acid (240 tpd) and ammonium nitrate (333 tpd). The ammonia and urea plants were commissioned in 1978 and the nitric acid and ammonium nitrate units in 1981. Ammonia production has remained at about 80% of capacity in recent years due to  - 12 - interruptions in natural gas supply from the Sichuan gas network. The plant also consumes much more energy than necessary, and there is scope for improving recovery of urea while reducing pollution (para 4.03 (ii)). After the Project, capacity utilization will increase to 89% as energy savings would release additional gas for increased production. 3.06 The Cangzhou Chemical Fertilizer Company's (CCFC) ammonia/urea plant, commissioned in 1978, has capacity of 1,000 tpd and 1,620 tpd of ammonia and urea, respectively. CCFC's operations have been affected significantly in recent years mainly by the shortage of natural gas, due to declining production from the Dagang oil fields. A gas pipeline scheduled for completion by end-1985 will provide the Cangzhou plant adequate gas from the Zhongyuan oil fields (Henan Province) to supplement gas available from the Dagang oil fields to operate the facilities at 86% of the capacity (Annex 4-4). However, the plant consumes much more energy than necessary, and there is scope for improving recovery of urea while reducing pollution (para 4.03 (iii)). 3.07 The Liaohe Chemical Fertilizer Company (LCFC) started fertilizer production in 1976. The ammonia and urea plants have a daily capacity of 1,000 tpd and 1,620 tpd, respectively. Capacity utilization has been maintained at high levels except in 1982, when it was 70% due to interruptions in water supply; this problem has been corrected. Availability of gas from the Panjing oil field for the Liaohe plant is expected to remain adequate through the project life to operate the facilities at full load. Rowever,the plant consumes much more energy than necessary, and there is scope for improving recovery of urea while reducing pollution (para 4.03 (iv)). 3.08 The Nanjing Chemical Industry Company (NCIC) is a large company with diverse activities. Its operations include nitrogenous and phosphate fertilizers, catalyst manufacturing, machine building, cement, plant erection and maintenance, and chemical research and design institutes. NCIC consists of 13 subsidiary plants/units with revenue generating units as independent profit centers. The nitrogenous fertilizer plant, originally built in 1937 as a very small-size plant, has been expanded and modified many times. The annual production capacity of the main units is 120,000 tpy ammonia, 120,000 tpy ammonium nitrate, 110,000 tpy ammonium bicarbonate, and 270,000 tpy sulfuric acid after the shutdown of one of the four existing sulfuric acid lines at the end of 1983 due to its age and corrosion and wear. Recent production of the ammonia and related units has been stable partly due to the unique plant configuration (in many cases oversized equipment and significant standby capacities, and impressive captive capability for building machinery for replacements). Despite such operational flexibility, many components of the ammonia unit are worn out and as a result the plant efficiency has declined resulting in high energy consumption. One more line of the sulfuric acid plant will be shut down in 1988 upon completion of a new sulfuric acid plant under the Project (para 4.03 (v)). 3.09 China Fertilizer Development Center (CFDC). Research and development work in the fertilizer sector and responsibility for design and engineering in China are shared by several chemical research and design institutes specializing in specific areas. Eight such regional and major  - 13 - research and design institutes report to MCI, which has been aware for some time of the need to coordinate their research and design activities to (a) avoid overlapping or duplication of efforts; (b) provide a focus to research planning activities; and (c) build up relevant expertise in specialized fields in priority areas. There is also need for: (i) training and technical assistance to build and upgrade knowledge of recent technological advances and to improve design capabilities; (ii) acquiring up-to-date equipment for research in fertilizers; and (iii) improving data handling, processing and analysis capabilities. CFDC was established in January 1984 to coordinate the above needs with a membership which includes eight chemical research and design institutes. CFDC's objectives, organization and management and areas for future research are given in - Annex 3. 3.10 CFDC recognizes that the present activities of the member institutes can be adjusted to achieve proper coordination only gradually. The Government has assured that it will cause CFDC to furnish to the Bank for the Bank's review and comments (a) by October 31, 1985, its four-year research and development plan including coordinated allocation of work among CFDC's eight member research and design institutes for the period 1986-1990; and (b) by October 31 of each year starting 1986 and up to 1990, its annual research and development plan for the next year including an assessment of achievements during the previous year. IV. THE PROJECT A. Project Objectives 4.01 The main objectives of the Project are to assist China in (a) implementing rehabilitation and energy saving measures in nitrogenous fertilizer plants of the five companies; (b) strengthening the beneficiary companies' capabilities in project implementation, plant operations and financial management; (c) strengthening the newly established CFDC and fertilizer research and design institutes for improved research and engineering capabilities in the fertilizer industry; and (d) developing strategies for modernization of the mediur-size nitrogen fertilizer plants. As noted earlier, the rehabilitation and energy saving measures under the Project are expected to have a significant demonstration effect for developing and implementing similar energy saving programs in China's other large- and redium-size fertilizer plants. The Project will thus support the Government's efforts to prepare industrial enterprises for efficient operations under the reformed economic structure by improving their energy efficiency and minimizing production costs. B. Project Description 4.02 The Project includes four components: (a) plant rehabilitation and energy saving component covering fertilizer plants of the five companies; (b) fertilizer research and development component covering CFDC and its eight member research and design institutes; Cc) technical assistance to the project implementation coordination unit of MCI; and (d) a nitrogenous fertilizer production cost study to be carried out by MCI.  - 14 - 1. Plant Rehabilitation and Energy Saving Component 4.03 The rehabilitation and energy saving component covers five fertilizer complexes belonging to the five companies-LNGCC, YNGCC, CCFC, LCFC and NCIC. The modifications and improvements are based on studies and proposals prepared by: (a) M. W. Kellogg (US) (MWK) for the energy saving modifications in the large ammonia plants at Luzhou, Yunnan, Cangzhou and Liaohe; these modifications will be designed to allow for a possible 10% capacity expansion of the plants in the future; (b) Snamprogetti (Italy) for the large urea plants in the same location as the ammonia plants; (c) Humphreys and Glasgow (UK) (HG) for the medium-size ammonia plant at Luzhou; and (d) UTI (US), Mbntedison (Italy) and Toyo (Japan) for the medium-size urea plant at Luzhou. HG has also carried out an inspection of the old ammonia plant at Luzhou, financed from the IDA-financed Technical Cooperation Credit (1412-CHA), to define the required rehabilitation work. These studies have been reviewed by the management of each plant, the domestic design institutes and the technical team of MCI. The modifications and improvements for the Nanjing fertilizer plant were identified and prepared by NCIC and the Nanjing Design Institute, and reviewed by the MCI technical team as well as by international consultants. The Bank staff have discussed the proposed modifications and suggested adjustments as necessary to optimize the project design. Project scope of the plant rehabilitation and energy saving com;.jnent is given in Annex 4-1. The plant rehabilitation and energy saving part of the Project includes five subcomponents as discussed below: (i) Luzhou Subcomponent: (a) implementation of energy saving modifications in the large 1,000 tpd ammonia plant; (b) installation of a hydrolysis unit and a low pressure absorption system in the large 1,620 tpd urea plant to reduce pollution and recover 8,000 tpy urea from liquid effluents; (c) implementation of revamping and energy saving measures, and expansion of capacity by 50% in the old, medium-size ammonia/urea plant (present capacity of 300 tpd ammonia and 500 tpd urea); (d) spare parts to maintain production at capacity; (e) process simulator, laboratory equipment and audio-visual aids for the training facilities at Luzhou; and (f) training abroad for about 52 staff in process operations and maintenance and through participation during basic engineering of the old ammonia/urea plant (155 man-months), and visits by foreign experts to China to provide training in process control and maintenance (8 man-months). (ii) Yunnan Subcomponent: (a) implementation of energy saving modifications in the 1,000 tpd ammonia plant; (b) installation of a hydrolysis unit in the 1,620 tpd urea plant to reduce pollution and recover 5,000 tpy urea; (c) spare parts to maintain production at capacity; and (d) training abroad for about 15 persons in process operations and maintenance (45 man-months). (iii) Cangzhou Subcomponent: (a) implementation of energy saving modifications in the 1,000 tpd ammonia plant; (b) installation of a hydrolysis unit in the 1,620 tpd urea plant to reduce pollution and recover 5,000 tpy of urea; (c) a process control system to improve operation of the ammonia plant; and (d) training abroad for about 17 persons in operations and maintenance (50 man-months). CCFC will sell about 20,000 tpy of surplus ammonia starting in 1988 to a 480,000 tpy diammonium phosphate  - 15 - plant to be built in Qinhuangdao (Hebei Province) as a joint venture project by China, Kuwait and Tunisia. (iv) Liaohe Subcomponent: (a) implementation of energy saving modifications in the 1,000 tpd ammonia plant; (b) installation of a hydro- lysis unit in the 1,620 tpd urea plant to reduce pollution and recover 5,000 tpy of urea; (c) addition of a dehydrogenation unit to the C02 gas stream to the urea plant to improve plant safety and increase urea produc- tion by 3,000 tpy; and (d) training abroad for about 17 persons in opera- tions and maintenance (50 man-months). Although LCFC will sell hydrogen from the purge gas recovery unit (one of the five energy saving modifica- tions in the ammonia plant) to a refinery of the Panjing Oil Company, it will have the flexibility to utilize the recovered hydrogen gas if required. (v) Nanjing Subcomponent: (a) addition of an anthracite- gasification line to the existing 9 lines, installation of a syngas com- pressor, and replacement and improvement of equipment in the ammonia plant as required. The ammonia production will increase to 150,000 tpy or by more than 25%; (b) improvements in the ammonium nitrate plant and addition of a 50,000 tpy porous granular ammonium nitrate unit to produce industrial grade ammonium nitrate; (c) installation of a 200,000 tpy single-train Pyrites-based sulfuric acid plant to replace two obsolete lines, one of which was shut down in 1983 and the other to be shut down in 1988; (d) improvements in plant utilities (power, water and steam), offsites and environmental system; and (e) training aids including audio-visual aids and process simulators, microcomputers and training abroad for about 20 staff in operations and maintenance and management (60 man-months). 4.04 The plant rehabilitation and energy saving component will also provide for overseas visits by staff of each of the five companies, domes- tic design institutes and MCI for engineering and procurement, i.e., equip- ment inspection for each of the five subcomponents (about 70 man-months). 4.05 The main benefits from the plant rehabilitation and energy saving component are summarized in Annex 4-2. The Project will (a) result in sig- nificant savings in specific energy consumption of natural gas, anthracite and electricity for ammonia production; and (b) increase production through rehabilitation of the plants. Energy consumption per ton of ammonia for feedstock and fuel will decrease between 6% to 14% and for electricity between 4% to 20%. The Project will also increase production of urea by 129,000 tpy, methanol by 29,000 tpy, ammonium nitrate by 24,000 tpy, and surplus ammonia for sale by 14,000 tpy, and replace production of 180,000 tpy of sulfuric acid. 2. Fertilizer Research and Development (CFDC) Component 4.06 The CFDC component will provide (a) research equipment and scientific instruments for CFDC's eight member research and design insti- tutes to expand their capabilities for fertilizer research and design work in several areas including chemical analysis of fertilizers, compound fertilizers, production processes, phosphate rock, sulfuric acid, catalysts, energy efficiency improvements and pollution control and engineering design; (b) computer hardware/software facilities; Nc) training  - 16 - aids; (d) training abroad (about 340 man-months) and in China by foreign experts (about 12 man-months) as well as scientific books and periodicals; and (e) overseas visits by local staff for procurement. Requirements under this component were identified and prepared by CFDC and reviewed by a consultant from the International Fertilizer Development Center. The data processing and computer needs have also been reviewed by consultants (Haldor Topsoe) under the IDA-financed Technical Cooperation Credit (1412-CHA). 3. Technical Assistance to MCI Component 4.07 The Project will provide up to 30 man-months of consultancy services for assistance in international procurement for the overall Project to the project implementation coordination unit of MCI (para 5.04). 4. Nitrogenous Fertilizer Production Cost Study 4.08 As stated in para 2.21 earlier, the Government's strategy in nitrogenous fertilizer industry is to undertake programs to improve efficiency of the existing plants through energy saving measures and technical rehabilitation, especially of large- and medium-size plants. Accordingly, comprehensive understanding on the cost structure of fertilizer production is necessary to develop a basis for (a) evaluating operational and energy efficiencies of nitrogen fertilizer production; and (b) developing strategies for modernization of the fertilizer industry. While adequate data is already available for the large-size nitrogen plants, there is need to develop such data for medium-size plants for which the potential for improvements in efficiency is substantial. Accordingly, MCI will carry out a study on fertilizer production costs for a selected sample of medium-size nitrogen plants (Annex 4-3). During negotiations understandings were reached that (a) MCI would discuss the terms of reference for the study and share the study's findings with the Bank; and (b) the study would be completed within the next 18 months. C. Raw Materials and Utilities 4.09 The supply situation and arrangements for natural gas, anthracite and pyrites for the plants under the Project are given in Annex 4-4. Despite the increase in production (about 129,000 tons of urea and 5,000 tons of surplus ammonia for sale from the four gas-based fertilizer complexes), the overall requirement of natural gas, including gas needed for utilities, for the Luzhou, Yunnan, Cangzhou and Liaohe complexes after rehabilitation and energy saving modifications would decrease by about 30 million normal cubic meters (Nm') or by 1.7Z. As noted in the previous chapter, the shortages of natural gas for the Luzhou, Yunnan and Cangzhou plants have, in the past, constrained plant operations. The potential for expanded gas production in the Sichuan Province, which provides gas for the Luzhou and Yunnan plants, is quite high. The Government expects to gradually increase the Sichuan gas production from the present 5 billion Nm3 to 7 and 10 billion Nm3 by 1990 and 2000, respectively. The Bank is currently processing a proposed technical assistance loan for the development of the Weiyuan gas field in the Sichuan basin with the objective of developing a rehabilitation program to maximize the ultimate recovery of gas reserves. Availability of natural gas for the Cangzhou  - 17 - plant will be adequate (para 3.06). Natural gas supply to the Liaohe plant is expected to remain satisfactory. Supply of natural gas in the future is therefore expected to be adequatc for all plants to operate at full load when the Project is completed. 4.10 Anthracite consumption for feedstock and fuel per ton of ammonia at Nanjing will decrease by about 14Z because of higher efficiency of the new processes under the Project. Pyrites consumption In the new sulfiric acid plant will be about 3X less than the consumption in the existing sulfuric acid lines. The present power and water supply systems and arrangements at each plant location are adequate to meet the needs after rehabilitation of the plants. Assurances were obtained that the Government will provide or cause to be provided adequate and timely supply of feedstock and raw materials to each of the companies to enable the operation at optimal capacity of their fertilizer plants after rehabilitation. D. Environmental Aspects 4.11 At Luzhou, Yunnan, Cangzhou and Liaohe complexes, while liquid effluents from the ammonia plants comply with environmental standards, the waste waters from the urea plants contain about 0.05% ammonia and between 1.5% and 1.7% urea. The high pressure hydrolizer units proposed under the Project would reduce the maximum ammonia and urea contents in treated liquid effluents from large plants to 5 milligram per liter (mg/1). At Nanjing, where pollution level is determined by operations of NCIC's several plants of different types, all liquid effluents from the nitrogen fertilizer complex will be treated before discharge. In addition, pollutants such as cyanogen will be removed in specific units through appropriate physical-chemical treatments. The overall sulfur dioxide (SO2) emission levels from the Nanjing nitrogen fertilizer complex at present amount to 180 kilograms per hour (kg/h) while the maximum discharge permitted by the local authorities is 190 kg/h for the whole complex. Therefore, NCIC's sulfuric acid plant will be designed through installation of a special ammonia scrubbing unit to discharge to the atmosphere only 50 parts per million (ppm) or about 10 kg/h of S02. Liquid effluents from the ammonia scrubbing unit will be sent to a nearby small-size fertilizer plant for conversion into ammonium sulphate, to be sold as fertilizer. Pyrite cinders will be pelletized and used at the Nanjing Iron & Steel Works factory located 5 km from NCIC. Liquid effluents from the wet scrubbing unit of the roasting section of the existing sulfuric acid lines will be eliminated by installing closed loops; the excess dilute sulfuric acid so produced will be used in NCIC's phosphate fertilizer complex. The levels of pollution before and after the Project for the five plants are shown in Annex 4-5. Proposed measures to be undertaken under the Project to achieve environmental levels compatible with international standards are satisfactory. During negotiations assurances were obtained that the companies will (a) build the facilities and operate the plants in accordance with environmental standards satisfactory to the Bank; and (b) carry out and furnish to the Bank environmental safety case studies, in accordance with the terms of reference satisfactory to the Bank, for their respective plants by December 31, 1985 for the Bank's review and comments. The studies will identify major accident hazards that could arise from the  - 18 - industrial activities, and indicate arrangements and controls in place to prevent or limit consequences of major accidents that might occur. V. PROJECT MANAGEMENT AND EXECUTION A. Engineering Arrangements 5.01 The basic engineering and part of the detailed engineering is to be provided by (a) MWK (US) for energy saving modifications in four large ammonia plants at Luzhou, Yunnan, Cangzhou and Liaohe--since the original plant facilities were engineered and supplied by MWK, it has access to full design and engineering details and MWK has also carried out such projects successfully in similar plants elsewhere; (b) Snamprogetti (Italy)-a.major urea process licensor with considerable experience in building hydrolysis units, for providing these units in the four large urea plants; and (c) HG (UK) for rehabilitation and energy saving measures in the medium-size ammonia plant at Luzhou, originally engineered and supplied by them using the ICI technology. For the medium-size urea plant at Luzhou, LNGCC has received proposals for process and engineering from three competent engineering firms--Toyo (Japan), Montedison (Italy) and UTI (US), and one of them will be selected to provide the basic and part of the detailed engineering. The services of international engineering firms in all cases will include supervision of detailed engineering to be carried out by the domestic design institutes and assistance in procurement, construction, erection and start-up, with total project management assistance estimated at about 330 man-months. Detailed engineering of the energy saving modifications common to all the four large ammonia/urea plants will be coordinated by MCI's project implementation coordination unit (para 5.04) to minimize duplication of efforts by each plant, and will be undertaken by the MCI's Design Institute No. 8 and the Chemical Industrial Engineering Corporation in Beijing. The basic and detailed engineering for the dehydrogenation unit at Liaohe will be carried out by the Chemical Industrial Engineering Corporation in Beijing. The remaining detailed engineering for items which are not common to all plants will be carried out by the Chengdu Design Institute for the Luzhou and Yunnan plants, No. 6 Design Institute of Chemical Industry for the Cangzhou plant, and the Chemical Industrial Engineering Corporation for the Liaohe plant. The Chinese design institutes have experience in carrying out the needed engineering work for the Project. 5.02 All basic and detailed design work for the nitrogen fertilizer and sulfuric acid plants at Nanjing is being undertaken by the Nanjing Design Institute except the design of the pyrites roaster and waste heat boiler of the sulfuric acid plant which is to be carried out by Lurgi (FRG). NCIC will also retain the services of Lurgi to review the design and engineering for the whole sulfuric acid plant. The present water scrubbing system in NCIC's ammonia plant to remove CO2 will be replaced by a propylene carbonate scrubbing system based on technology satisfactorily adopted in other ammonia plants in China. 5.03 Assurance has been obtained that the Government will employ engineering firms and consultants with qualifications, experience and  - 19 - terms and conditions of employment satisfactory to the Bank, to assist the companies in carrying out their respective subcomponents. B. Project Management and Status 5.04 Project Organization. MCI will have primary responsibility for supervision of overall project iWmementation. In view of the complexity of the Project involving several plants and institutions, MCI has established a project implementation coordination unit within the Ministry to ensure effective coordination of implementation of the overall Project. It will continuously review progress including procurement and take timely action to remove any constraints affecting project implementation. Assurances were obtained that the Government will (a) maintain the unit established within MCI to coordinate implementation of the Project, with staff and responsibilities acceptable to the Banit; and (b) employ by November 30, 1985, a procurement advisor for the MCI's project unit for assistance in international procurement of equipment and material. Implementation of tne individual subcomponents of the Project is the responsibility of the five companies for their respective plant rehabilitation and energy saving modifications, and CFDC for the fertilizer research and development component. The civil works and erection of the facilities will be planned and carried out in a manner so as to minimize - production interruptions. Procurement of equipment and materials will be coordinated by the MCI's project implementation coordination unit, and handled by the companies and CFDC. International procurement will be channelled through the China National Chemical Construction Company (CNCCC) under MCI. 5.05 The management and staff of the MCI's project unit, five companies and CFDC are competent and able to implement the Project efficiently. The organization chart of the MCI's project implementation coordination unit is given in Annex 5-1. 5.06 Project Status. SPC approval of the Project was given in October 1984. Proposals for the basic and part of the detailed engineering and project management assistance ha'e been received from NWK for energy saving modifications in the four large ammonia plants and Snamprogetti for hydrolysis units in the four large urea plants. LNGCC expects to receive a proposal for the basic and part of detailed engineering and project management assistance for the medium-size ammonia plant from HG in May 1985. Proposals for process and engineering for the medium-size urea plant at Luzhou from UTI, Montedison, and Toyo have been received, and are being reviewed by LNGCC and MCI. C. Implementation Schedule 5.07 From the date of award for engineering contracts, the Luzhou, Yunnan, Cangzhou and Liaohe subcomponents would take 30 months for completion. The Nanjing subcomponent is expected to be completed by December 1987. While sufficient progress has already been made for engineering arrangements, and some engineering contracts are expected to be awarded before end June L985, it is conservatively assumed that all engineering contracts will be signed by December 31, 1985. The fertilizer  - 20 - research and development (CFDC) component is expected to be completed by December 1987. The overall Project is expected to be completed by June 30, 1988. Project implementation schedule is given in Annex 5-2. The project schedule, which is different from the standard profile of industrial projects, is achievable consideriug that MCI has already made sufficient progress toward engineering arrangements, most of the engineering firms involved have experience of working in China, and the civil works and erection involved are limited compared with a greenfield industrial project. D. Training 5.08 The five companies have had previous experience in project implementation and there is a nucleus of good and experienced engineers and planners. Their technical skills in operating and maintaining the plants and management skills are also good. The training program under the Project aims at upgrading these skills by providing exposure to experience outside China and in areas related to specialized technology and machinery. Training programs for CFDC and its member research and design institutes will provide for training of selected personnel abroad to build and upgrade knowledge of recent advances in technology, and bringing some foreign researchers to China for exchange of experience in selected research areas and lectures on specialized topics. Assurances have been obtained that (a) the five companies will develop their training programs by September 30, 1985 for review with the Bank and implement them in consultation with the Bank; and (b) the Government will cause CFDC to develop its training programs by September 30, 1985 for review with the Bank and implement them in consultation with the Bank. VI. CAPITAL COST, FINANCING PLAN, PROCUREMENT AND DISBURSEMENT A. Project Capital Cost 6.01 The total project cost is estimated at US$173.8 million equivalent including US$110.3 million equivalent or 63.5% of the total in foreign exchange. The total financing required for the Project including interest during construction (US$13 million) is estimated at US$186.8 million equivalent including US$122.7 million equivalent or 65.7% of the total in foreign excbange. The capital cost estimates are detailed in Annex 6-1 and summarized in the table on the following page. 6.02 The base cost estimates are in January 1985 prices and are based on (a) the estimates of the project authorities and MCI following information submitted by engineering firms; and (b) the Bank's own cost information obtained from potential suppliers. Phyz'cal contingencies are calculated at 10% of the base cost estimate; no physical contingencies are included for spare parts for the existing plant aid machinery for the Luzhou and Yunnan plants, training and training aids, and for contracts (US$2.5 million for the Nanjing plant) already effective. For base cost and physical contingencies, the exchange rate of Y 2.80 = US$1.00 prevailing in January 1985 has been used. For the calculation of price  - 21- Summary of Capital Cost Estimate a|b/ Yuan Million US$ Million Z Local Foreign Total Local Foreiga Total of Total Plant Rehabilitation and Energy Saving Component Engineering and Licenses 13.8 19.8 33.6 - 4.9 7.1 12.0 6.9 Equipment and Materials 41.9 143.6 185.5 15.0 51.3 66.3 38.2 Taxes 4.5 - 4.5 i.6 - i.6 0.9 Freight and Insurance 12.7 14.1 26.8 4.5 5.1 9.6 5.5 Civil Works and Erection 62.8 3.4 66.2 22.4 1.2 23.6 13.6 Project Management Services 1.6 14.9 16.5 0.6 5.3 5.9 3.4 Spare Parts 1.4 21.2 22.6 0.5 7.5 8.0 4.6 Training Aids 0.3 4.3 4.6 0.1 1.5 1.6 0.9 Training 0.1 4.2 4-.3 - 1.5 1.5 0.9 Base Cost Estimate (ACE) 139.1 225.5 364.6 49.6 80.5 130.1 74.9 Physical Contingency cJ 13.9 20.1 34.0 5.0 7.2 12.2 7.0 Price Contingency _Je/ 8.6 14.0 22.6 7.8 12.6 20.4 11.7 Installed Cost 161.6 259.6 421.2 62.4 100.3 162.7 93.6 In:remental Work4ng Capital o.7 _ 0.7 0.3 0.3 0.2 Subtotal 162.3 259.6ff 421.9 62.7 100.3f/ 163.0 93.8 Fertilizer Research and Development (CFDC) Component Equipment ./ 1.0 11.4 12.4 0.3 4.1 4.4 2.5 Computer Hardware/Software 0.3 9.1 9.4 0.1 3.2 3.3 1.9 Training 0.8 4.2 5.0 0.3 1.5 1.8 1.0 Project Management - 0.2 0.2 - 0.1 0.1 0.1 Subtotal hI 2.1 24.9 27.0 0.7 8.9 9.6 5.5 Price Contingency if 0.1 1.2 1.3 0.1 1.1 1.2 0.7 Subtotal 2.2 26.1 28.3 0.8 10.0 10.8 6.2 Tozal Project Cost 164.5 285.7 450.2 63.5 110.3 173.8 100.0 Interest During Construction (IDC) 1.6 32.0 33.6 0.6 12.4 13.0 Overall Financing Required 166.1 317.7f/ 483.8 64.1 122.7f' 186.8 a/ Base cost and physical contingencies (in January 1985 prices) have been calculated using an exchange rate of Yuan 2.80 - US$1.00 as of the estimating date. Project is exempt from customs duties and taxes on imported equipment. b/ Cost of the technical assistance to MCI component for overall project implementation is included under the plant rehabilitation and energy saving component. There is no additional cost for the fertilizer production cost study as it will be carried out by MCI's own staff. cJ 10Z of base cost estimate excluding: (i) a total of US$4.4 million for spare parts for the Luzhou and Yunnan plants; (ii) training aids and training; and (iii) US$2.5 million for contracts already signed by NCIC with Lurgi (FRG) and Chemetics International Co. Ltd. (Canada) for the sulfuric acid plant. dl No price contingencies are incladed on US$2.5 million for NCIC's sulfuric acid plant. eJ Total price contingency (as Z of BCE and physical contingency) for the plant rehabilitation and energy saving component is estimated at about 14.3Z when costs are expressed in US dollar and about 5.7% when costs are expressed in yuan. f/ Includes US$9.8 million or Y 25.4 million of indirect foreign exchange. &/ Includes research equipment, scientific instruments and training aids. h/ Including physical contingencies. i1 Total price contingency (as Z of BCE and physical contingency) for the CFDC component is estimated at about 12.5% when costs are expressed in US dollar and about 5% when costs are expressed in yuan.  - 22 - contingencies, it is assumed that exchange rate adjustments will, on average, be made to maintain "purchasing power parity". On this basis, price escalation for both foreign and local costs (a) when expressed in US dollars, is based on expected international annual inflation rates of 5% in 1985, 7.5% in 1986 and 8% in 1987 and 1988; (b) when expressed in yuan, is based on expected domestic inflation of 3Z p.a. in 1985-1988. While the Project is exempt from import taxes and duties, the companies will pay sales tax on locally procured equipment and material. 6.03 The capital cost breakdown by project components and plants is given in the table below. Capital Cost Breakdown a/ Yuan Million US$ Million Project Components Local Foreign Total Local Foreign Total X Plant Rehabilitation & Energy Saving - Luzhou 40.2 118.9 159.1 15.6 46.3 61.9 33.1 - Yunnan 14.4 35.8 50.2 5.6 13.8 19.4 10.4 - Cangzhou 13.5 33.4 46.9 5.3 13.0 18.3 9.8 - Liaohe 15.3 30.4 45.7 5.9 11.8 17.7 9.5 - Nanjing 80.5 73.1 153.6 30.9 27.8 58.7 31.4 Subtotal 163.9 291.6 455.5 63.3 112.7 176.0 94.2 Fertilizer R&D (CFDC) 2.2 26.1 28.3 0.8 10.0 10.8 5.8 Total Financing Required 166.1 317.7 483.8 64.1 122.7 186.8 100.0 ZMMMMM~ :MMM== MC=9 = ====M a! Cost of the technical assistance to MCI component for overall project implementation is included under the plant rehabilitation and energy saving component. There is no additional cost associated with the fertilizer production cost study component, as it will be carried out by the MCI's own staff. 6.04 About 94% of the total financing required is for the plant rehabilitation and energy saving component including technical assistance for the MCI project unit, and the remaining 6% for the fertilizer research and development (CFDC) component. The above estimates include about 380 man-months of foreign consultant services for technical assistance in project management and training for a total base cost (excluding concingencies) of about US$5.1 million. B. Financing Plan 6.05 The proposed Bank loan of US$97.0 million would meet 79.1% of the total foreign exchange and 52.5% of the total financing (net of taxes) required. The proposed financing arrangements are summarized in the table on the following page. 6.06 The proposed Bank loan will be made to GOC at the Bank's standard variable interest rate for 20 years including 5 years of grace with a  - 23 - Financinx Plan (in US$ million equivalent) X of Conponent Source Local Foreigns/ Total Subtotal I. Plant Rehabilitation & Energy Saving Component - Luzhou Plant (LNGCC) IBRD Loan - 40.3 40.3 65 Donestic Bank Loan 15.6 1.4 17.0 27 LKGCC - 4.6 4.6 8 Subtotal 15.6 46.3 61.9 100 - Yunnan Plant (YNGCC) IBMD Loan - 10.1 10.1 52 YNCC - 5.6 3.7 9.3 48 Subtotal 5.6 13.8 19.4 100 - Cangzhou Plant (CCFC) IBBD Loan - 11.1 11.1 61 CCFC 5.3 1.9 7.2 39 Subtotal 5.3 13.0 18.3 100 - Liaohe Plant (LCFC) IBRD Loan - 8.7 8.7 49 Domestic Bank Loan 5.6 0.2 5.8 33 Pan ing Oil Cozpany/f - 1.6 1.6 9 LCFC 0.3 1.3 1.6 9 Subtotal 5.9 11.8 17.7 100 - Nanjing Plant (NCIC) IBRD Loan - 16.8 16.8 29 NCIC 30.9 11.0 41.9 71 Subtotal 30.9 27.8 58.7 100 Subtotal I 63.3 112.7 176.0 1I. Fertilizer R&D IBRD Loan - 10.0 10.0 93 (CFDC) Component CFDC 0.8 - 0.8 7 Subtotal II 0.8 10.0 10.8 100 Total (1+II) 64.1 122.7 186.8 _ - Z of Total Memo Items: Financing Plan for the IBRD - 97.0 97.0 51.9 Total Project Domestic Bank Loans 21.2 1.6 22.8 12.2 Beneficiary Companies 42.1 24.1