China - Third Montreal Protocol Ozone Depleting Substances Phase Out Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 13966-CHA MULTILATERAL FUND UNDER THE MONTREAL PROTOCOL MEMORANDUM AND RECOMMENDATION OF THE DIRECTOR OF THE CHINA AND MONGOLIA DEPARTMENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE REGIONAL VICE PRESIDENT, EAST ASIA AND PACIFIC REGION ON A PROPOSED OZONE PROJECTS TRUST FUND GRANT IN THE AMOUNT EQUIVALENT TO $90.1 MILLION TO THE PEOPLETS REPUBLIC OF CHINA FOR A THIRD MONTREAL PROTOCOL OZONE DEPLETING SUBSTANCES PHASEOUT PROJECT JUNE 23, 1995 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (As of January 1995) Currency Name = Renminbi Currency Unit = Yuan (Y) = 100 Fen $0.12 = Y I.00 $1.00 = Y8.50 WEIGHTS AND MEASURES I meter (m) = 3.28 feet I kilometer (kni) = 0.62 miles I hectare (ha) = 10,000 square meters = 15 mu 1 kilogram (kg) = 2.204 pounds I metric ton (MT) = 2,204.6 pounds ABBREVIATIONS AND ACRONYMS (main text) CFC Chlorofluorocarbons CIB China Investment Bank EA Environmental Assessment GOC Government of China ICB International Competitive Bidding MFMP Multilateral Fund of the Montreal Protocol MOF Ministry of Finance MP Montreal Protocol MPEC Montreal Protocol Multilateral Fund Executive Committee NEPA National Environmental Protection Agency ODS Ozone Depleting Substances OTF Ozone Projects Trust Fund PMO Project Management Office UNDP United Nations Development Program UNEP United Nations Environment Program UNIDO United Nations Industrial Development Organization USEPA United States Environmental Protection Agency FISCAL YEAR January I - December 31  FOR OFFICIAL USE ONLY CHINA THIRD MONTREAL PROTOCOL OZONE DEPLETING SUBSTANCES PHASEOUT PROJECT PROJECT AND GRANT SUMMARY Recipient: People's Republic of China Implementing Agency: National Environmental Protection Agency (NEPA) Beneficiaries: NEPA, Participating Financial Agent(s) and Enterprises Poverty: Not Applicable Amount: $90.1 million equivalent Terms: N/A Commitment Fee: N/A Financing Plan: See Schedule A Economic Rate of Return: N/A Maps: N/A Project ID Number: CN-MT-3409 This documcnt has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  I  MEMORANDUM AND RECOMMENDATION OF THE DIRECTOR OF THE CHINA AND MONGOLIA DEPARTMENT TO THE REGIONAL VICE PRESIDENT EAST ASIA AND PACIFIC REGION 1. I submit for your approval the following memorandum and recommendation on a proposed Ozone Projects Trust Fund Grant to the People's Republic of China for $90.1 million to help finance a project to reduce ozone depleting substances (ODS) consumption and production as called for in China's ODS Phaseout Program. Background 2. China is the developing world's largest consumer and producer of ODS. In 1991, China's ODS consumption was about 50,000 tons and production was about 30,000 tons. ODS consumption has been growing at an average rate of about 11 percent per year which, if unconstrained, would push consumption to 84,000 tons by 1996. The Governmvnt ratified the Montreal Protocol (MP) in June 1991 and thus agreed to reduce ODS consumption by 1996 back to the 1991 level, which was 50,000 tons; it would then reduce that level by a further 50 percent by 2000, then completely phase out ODS by 2010. China is developing a program to meet this commitment, but its efforts are hampered by lack of funds and access to technology. 3. China is eligible for financing from the Multilateral Fund under the MP (MFMP), created to provide support to eligible developing countries to meet their MP obligations. The MP Executive Committee (MPEC) manages the MFMP. The Bank, the United Nations Development Program (UNDP), the United Nations Environment Program (UNEP), and the United Nations Industrial Development Organization (UNIDO) are the implementing agencies. The Ozone Projects Trust Fund (OTF) Agreement, with the Bank acting as Trustee, governs Bank projects. The Chinese agency responsible for the ODS phaseout program is the National Environmental Protection Agency (NEPA), the head of the Leading Group for Ozone Layer Protection. NEPA has established a Project Management Office (PMO), assisted by nine Leading Group member ministries and the China Investment Bank (CIB), to manage the ODS phaseout program. 4. With the help of the MP, China has launched a 15-year program to introduce new technology and phase out all ODS production and consumption. This Country Program includes policy, strategy, costs and an action plan to achieve ODS phaseout involving external funding and technology support. It was prepared with UNDP support using MPEC-approved funds and the Trustee's assistance, and was approved by MPEC in March 1993. 5. Five industrial sectors basically account for all of China's ODS usage: foams (37 percent), refrigeration and air-conditioning (27 percent), aerosols (18 percent), solvent  cleaning (10 percent) and fire protection (8 percent). Rapid ODS phaseouts are planned for sectors where substitute technologies are widely available, such as the foam and aerosol sectors. Use in other sectors, including refrigeration and air-conditioning, will be phased out more slowly. ODS production would be phased out on a schedule consistent with domestic consumption needs, to be completed by 2010. 6. China's ODS Country Program (summary in Annex 1) aims to cap and then reduce ODS consumption while introducing ODS replacement technologies through a strong regulatory framework. The Government has developed and started to implement new policies, including regulation of supply (import and local production), controls or bans of certain substances, price changes, taxes and other incentives and penalties. China has already banned new ODS-based production facilities in the halon and aerosol sectors (1990 and 1991, respectively) and complete bans on ODS use in these sectors are planned to coincide with the adoption of substitute technologies by local industries. A new regulation became effective February 1994 banning new production facilities of chlorofluorocarbons (CFCs). Effective January 1995, imports of refrigerators and freezers using CFCs, and manufacturing devices for auto air-conditioning with CFC-12 refrigerants will not be allowed. Simultaneously, import duties on equipment using non-CFCs in the production of refrigerators, freezers and compressors will be reduced. 7. In response to the need for a fast start on China's ODS phaseout program, the Trustee approved the first and second ODS Phaseout Projects in October 1993 and May 1994, respectively. Both projects have started implementation. As of June 15, 1995, out of a total grant of $11.8 million that was committed, $2.9 million has been disbursed. Upon completion of ODS I and II, 14,000 tons of ODS will be eliminated. This proposed Third Project is a continuation of the phaseout effort. Other institutions are also providing support. UNDP provides technical assistance through institutional strengthening of the PMO, demonstration ODS phaseout projects in solvent cleaning and foams, and revision of fire codes and standards to support halon phaseout. UNIDO assists in the financing of projects in tobacco processing and other industries. Together with UNDP, the United States, through the US Environmental Protection Agency (USEPA), provides assistance to develop a national halon recycling program, and about 150 halon recycling units were projected to be in operation by the end of 1994. In addition, USEPA is undertaking a project in China to develop CFC-free, energy-efficient household refrigerators for the Chinese market. Canada provides bilateral support for development of a project in the commercial refrigeration subsector in Sichuan Province. 8. The ODS phaseout program is part of a larger Bank effort to help the Chinese reverse the environmental degradation stemming from rapid industrialization based on obsolete technologies and a pricing system applied under central economic planning. Substantial progress has been made in creating a regulatory framework and in promoting environmental protection while pursuing sustainable development. The Bank has been actively involved in assisting China in developing its overall environmental policies and actions, and an environmental strategy paper has been prepared and discussed with the  - 3 - Government. A number of Bank-assisted environmental operations1 are under implementation, and projects are being prepared in Hubei, Yunnan and Guangxi. Project Objectives and Design 9. The Project objectives are to (a) support China's total ODS phaseout program by establishing an efficient and flexible institutional mechanism to prepare, appraise, finance and implement a large number of subprojects, (b) implement cost-effective priority subprojects; and (c) allow ODS phaseout to proceed at or ahead of current schedule. 10. The proposed project design is to use a financial umbrella agreement between the Trustee and the Government, with NEPA as executing agency. The Government, represented by the Ministry of Finance (MOF), will entrust CIB and possibly other financial institutions to act as financial agent(s) to channel MFMP resources from the OTF to beneficiary enterprises. The proposed amount under the umbrella agreement would be sufficient to cover subprojects up to the end of 1996. Subproject financing will be subject to Trustee and MPEC approval in accordance with the Bank Procedures2 for MP operations. Once MPEC approves a subproject, MFMP will disburse funds into the OTF account under the umbrella agreement established for this Project. Subprojects are to be submitted for MPEC approval in several tranches. The financial agent(s) would appraise and supervise subprojects, and administer Grant funds. Project Description 11. The Project will support 60 to 80 subprojects in all ODS user and producer industries. The subprojects will be based on ODS-free or ODS-reduced technology and will provide: (a) technical and financial assistance to enterprises for technology transfer, design, training and implementation; (b) assistance in closing CFC production and halon plants; and (c) technical assistance to NEPA and the financial agent(s) in project development and implementation. In July and December 1994, MPEC had already approved 22 subprojects for a total grant of $29.4 million in the commercial and household refrigeration, foam, aerosol and halon subsectors (Annex 2). Identification and development of additional subprojects have started and new subprojects will be ready for MPEC approval during 1995 and 1996. The projected average subproject size is about $1.2 million. The Environmental Technical Assistance Project, the Southern Jiangsu Environmental Protection Project, the Beijing Environmental Protection Project, the Liaoning Environment Project and the Shanghai Environment Project. 2 Bank Procedures (BP10.21), issued in November 1993, Investment Operations Financed by the Multilateral Fund for the Implementation of the Montreal Protocol.  - 4 - Subproject and Eligibility Criteria 12. Subprojects should be on the priority list in the China ODS Country Program or confirmed by NEPA as essential to the Country Program objectives. Subprojects should reduce ODS consumption and production in China in a tangible manner and serve as demonstrations. They should be cost-effective and based on environmentally sound technologies. They should develop substitutes for MP-controlled substances, and further recycle controlled substances or substitutes, taking into account the national industrial policy of China. The OTF provides grants to enterprises implementing the subprojects. Financial eligibility should be determined during subproject preparation and appraisal. Financial appraisal shall include an evaluation of the beneficiary enterprises' financial viability, as measured by a debt service coverage ratio of no less than 1.2 times after subproject completion and upon attainment of full production capacity. The technical appraisal shall include an assessment of the impact of the proposed subprojects on ODS reduction and compliance with national and local environmental regulations. 13. Incremental costs of subprojects eligible for OTF funding are defined according to Trustee and MPEC guidelines; and these include (a) capital costs (excluding import duties and excise taxes), and (b) any eligible incremental operating costs. Project Costs and Financing Arrangements 14. Total project cost estimates under the umbrella agreement are $127.6 million, of which about $90.1 million are incremental costs eligible for OTF grant funding. Grant funds will likely include $87.3 million for subproject financing (including 15 percent physical and price contingencies), $2.7 million for agency fee and charges (3 percent of grant amount), and $0.1 million for institutional capacity building. The balance ($37.5 million) will be self-financed by the enterprises and/or borrowed from commercial sources. The financing plan of each subproject would cover total investment cost plus any eligible incremental operating costs (Schdule A). During negotiations, assurances were obtained from the Government that funds for incremental costs will be channeled to the participating enterprises as grants through the financial agent(s) and that satisfactory financing plans for the balance of project costs will be confirmed by the financial agent(s) during subproject appraisal. Project Implementation 15. Relevant ministries are responsible for preparation and implementation of subsector strategy studies and identification of subprojects. In 1994, NEPA assigned to its Foreign Economic Cooperation Office the oversight function of its PMO. The PMO is responsible for managing the ODS operations and coordinating with ministries and enterprises. Participating enterprises, assisted by design institutes, will be responsible for subproject implementation. MPEC previously approved $450,000, administered by NEPA, to build up NEPA's overall capabilities to coordinate the country's ODS phaseout program through the aforementioned PMO. However, NEPA/PMO management capability is still at a developmental stage; thus, this Project will provide additional institutional development  - 5 - assistance to the PMO. During negotiations, assurances were obtained from the Government that NEPA will maintain the PMO, with adequate staffing and with functions and responsibilities satisfactory to the Trustee, throughout the project period 16. Having gained experience in the appraisal of ODS subprojects under ODS I and II, CIB will continue as the financial agent for ODS III. However, other eligible financial institutions may be added during ODS III implementation, based on assessment of their eligibility and agreement between the Govermment and Trustee. Each financial agent will be responsible for preparation of subproject appraisal reports. It will carry out financial and economic appraisals, incorporating technical appraisals from NEPA, and supervision of subproject implementation, including, inter alia, procurement and disbursement, and preparation of subproject progress and completion reports. The PMO will contract out technical appraisals, coordinate preparation of subsector strategy studies and identification and preparation of subprojects, supervise the financial agent, ensure that subproject implementation corresponds to MPEC approval, prepare the overall Project progress and completion reports, ensure compliance with environmenital regulations, and oversee preparation of audit reports. Out of the 3 percent agency fee and charges, 2 percent will be paid to the financial agent and 1 percent to the PMO for their services. This service charge is substantially higher than in the first two ODS projects in China, but comparable to OTF projects in other countries. The 1 percent charge in the first two Projects proved to be well below CIB costs and contributed to the initial reluctance of CIB to participate in this Project. The PMO's role has increased substantially to ensure better Project implementation, and its services are eligible for finding under MPEC guidelines. 17. The following documents will describe the responsibilities of each party involved in the Project: (a) a Grant Agreement between the Government and the Trustee, (b) an Implementation Agreement to be signed by MOF, NEPA and CIB and/or other financial agent(s) (where another financial institution has been selected as financial agent, a separate Implementation Agreement with MOF and NEPA would be required); and (c) Subgrant Agreements between the financial agent(s) and participating enterprises. The Subgrant Agreement for each subproject will, inter alia, require each participating enterprise to complete the subproject satisfactorily, to eliminate use of ODS, and to maintain satisfactory financial viability using indicators as agreed with the Trustee. Signing of the Implementation Agreement with C.B, satisfactory to the Trustee, is a condition of effectiveness. During negotiations, assurances were obtained from the Government that subgrant agreements with each participating enterprise will follow a model subgrant agreement approved by the Trustee. The Trustee will supervise the Project, including monitoring work of NEPA, PMO and the financial agent(s), as required under its Trustee obligations. Procurement and Disbursements 18. Procurement procedures will follow Bank Guidelines for lending through financial institutions and would be the same as those for Bank-financed CIB projects that the Trustee has reviewed and found satisfactory. Such procedures would also be substantially in line  - 6 - with procurement methods in other Bank-financed environmental projects in China. The financial agent(s) will satisfy itself that goods and services to be purchased are for the subprojects and are reasonably priced, by ensuring that the Grant recipient has canvassed the main sources of supply and purchased from the most advantageous sources. CIB has implemented many World Bank projects and is experienced in handling procurement matters following Bank procurement procedures. New financial agents will have to demonstrate their abilities to carry out procurement according to Bank procedures. Procurement for contracts over $2 million would be by international competitive bidding (ICB). This method of procurement is expected to apply to about 20 percent of the Grant. Contracts of $2 million or below and above $250,000 would be awarded after evaluation and comparison of quotations solicited from at least three qualified suppliers from at least two countries. This method of procurement is expected to apply to some 60 percent of the Grant. Contracts below $250,000 would be awarded after evaluation and comparison of quotations solicited from at least three qualified suppliers. Proprietary items would be procured by direct contracting. For procurement under ICB procedures, bidding documents agreed between the Government and Trustee would be used and domestic preference would be allowed. All ICB contracts, proprietary contracts, and all consultancy contracts in excess of $100,000 for firms and $50,000 for individuals would be subject to the Trustee's prior review. All other contracts would be subject to post-review by the Trustee, and the financial agent(s) would maintain all relevant records for this purpose. 19. As the Grant is not expected to be signed until mid 1995, retroactive financing is proposed for up to 20 percent of the total Grant for contracts entered into after June 30, 1992,3 contingent upon MPEC approval of the subprojects and procurement consistent with Bank procurement guidelines. Funds are expected to be fully disbursed by June 30, 2000. Procurement procedures and the disbursement schedule are given in Schedule B. The timetable for processing the Project is given in Schedule C. Subproject eligibility and operational mechanisms are detailed in Annex 3. Project Sustainability 20. This Third ODS Phaseout Project provides financing and technology for implementation of priority operations identified in the ODS Country Program action plan. It is sustainable because of strong government commitment and compensatory mechanisms to participating enterprises. China is committed to the phaseout of ODS as required in its obligations under the Montreal Protocol. This commitment is demonstrated through China's approval of the ODS Country Program, which includes establishment of a formal ODS phaseout institutional implementation framework and adoption of a satisfactory policy framework that initially bans expanded ODS use. During negotiations, assurances were obtained from the Government that NEPA will moni or implementation of the Country Program, including subsector strategy studies, and inform the Trustee from time to time 3 Under MPEC guidelines, costs are eligible for retroactive financing from date of Montreal Protocol signature -June 1991 for China.  - 7 - about such implementation. Nonetheless, some enterprises may not yet be fully convinced of the need to convert to non-ODS technology, or may be reluctant to convert, fearing revenue losses and additional costs. Grant funding will compensate for these commercial and technical risks. The Project's emphasis on participating enterprises' financial viability and sectoral approach would also contribute to sustainability of the ODS program efforts. Lessons from Previous Bank Involvement 21. The Trustee currently is developing OTF projects simultaneously in about 20 countries, including Mexico, Brazil, India, Jordan, Philippines, Thailand, Turkey, Venezuela and several Eastern European countries. So far, only one project in Venezuela has been completed. In China, the first two projects are under implementation. Key operational lessons from implementation of the ODS operations highlight the importance of: institutional capacity of recipient countries to sustainable ODS phaseout; development of a comprehensive national phaseout policy; strong industry/central government/local government cooperation; use of umbrella grant agreements to streamline internal Bank project processing; a strong technical support body to the international implementing agencies to review project preparation activities; and transparent and consistent Montreal Protocol policies as the basis for effective project implementation. These lessons apply to China as well. Of particular relevance for sustainable ODS phaseout activities in China are training and institution building of local implementing agencies and financial agents involved; sound sector phaseout strategy studies as precondition of a national program; flexibility in project design; well-prepared and documented subprojects; and government/industry familiarity with ODS program objectives and requirements. Rationale for Funding from the MFMP 22. The Project meets the applicable project eligibility criteria as stated in the Implementation Guidelines and Criteria for Project Selection established by the Executive Commnittee of the MFMP. Environmental Aspects 23. While this is an environmental protection project, it harbors some environment- related risks. Several subprojects in foams and aerosols use flammable and toxic hydrocarbons. Each subproject includes satisfactory safety features and training to reduce fire risks to acceptable levels. Enterprises will prepare environmental assessments according to local regulations approved by NEPA. Local environmental bureaus are responsible for the environmental assessment (EA) reviews and supervision during the subproject implementation stage. The approved EAs will be attached to subproject appraisal reports. Enterprises will also adopt fire safety measures according to local regulations approved by the Ministry of Public Security. Local fire protection bureaus are responsible to supervise fire safety measures during subproject implementation.  -8 - Benefits 24. The Project will assist the Government in implementing an accelerated ODS phaseout program by providing financing and technical assistance for priority subprojects and by institutional support to NEPA/PMO and the financial agent(s). It will support the Government in meeting its medium-term target of maintaining ODS consumption in 1996 at 1991 levels and then reducing that level by a further 50 percent by 2000. The first two tranches represent about 7,700 tons of ODS phase out, or about 9 percent of projected unconstrained 1996 consumption. Future tranches are expected to phase out an additional 13,000 tons of ODS or another 15 percent of projected unconstrained 1996 consumption. Risks 25. Subprojects are based on commercially proven teclmology from local and foreign sources and include substantial technical support. Particular attention would be paid to the choice of such technology to ensure optimal ODS reduction while also taking into account economic, maintenance, and safety considerations. Compensating incremental costs through grants will ensure that enterprises will have a financial incentive to initiate action. Satisfactory subproject financing plans will be agreed prior to subproject approvals. The main risk is institutional. Institutional weakness of local agencies and unfamiliarity with ODS program objectives and requirements could hinder project execution. Thus, support to local institutions for the administration and implementation of the proposed Project is important. The proposed technical assistance component for PMO and the financial agent(s) is designed to meet this need. Substantial training for procurement and disbursement procedures will be included. Agreed Actions 26. At negotiations, assurances from the Government were obtained that: (a) funds for incremental costs will be channeled to participating enterprises as grants through the financial agent(s), and satisfactory financing plans for the balance of project costs will be confirmed by the financial agent(s) during subproject appraisal (para. 14); (b) NEPA will maintain the PMO, with adequate staffing, and with functions and responsibilities satisfactory to the Trustee, throughout the project period (para. 15); (c) subgrant agreements with each participating enterprise will follow a model subgrant agreement acceptable to the Trustee (para. 17); and (d) NEPA will monitor implementation of the Country Program, including subsector strategy studies, and inform the Trustee from time to time about such implementation (para. 20).  -9- 27. The condition of effectiveness of the Grant will be as follows: the signing of an Implementation Agreement that describes the responsibilities of NEPA and its PMO and CIB under the Grant Agreement (para. 17), satisfactory to the Trustee by MOF, NEPA and CIB. Recommendation 28. I am satisfied that the proposed Grant would comply with the relevant provisions of the Ozone Projects Trust Fund in Resolution 91-5 of the Executive Directors, and I recommend that the Regional Vice President approve it. Nicholas C. Hope Director China and Mongolia Department East Asia and Pacific Region Attachments Washington, D.C. June 23, 1995  - 10- Schedule A CHINA THIRD ODS PHASEOUT PROJECT PROJECT COST AND FINANCING ($ million) Project Costs Financing Plan Investment Cost Incr. OTF Local Foreign Total Oper. Total Grant Others Total Cost 2 S Subprojects La IstTranche(06/94) 7.8 9.5 17.3 0.5 17.8 10.5 7.3 17.8 2nd Tranche (12/94) 19.0 2.0 21.0 19.0 4.0 23.0 3rd/4th Tranches (07& 12/95) 40.7 5.5 46.2 30.5 13.7 44.2 1996 Tranches 38.5 4.0 42.5 30.0 12.5 42.5 Subtotal 115.5 12.0 127.5 90.0 37.5 127.5 Technical Assistance & Training 0.1 0.1 0.1 TOTAL 115.5 12.0 127.6 90.1 37.5 127.6 laFigures for 1995 and 1996 tranches are indicative. L2 OTF grant includes the investment cost eligible for financing, net incremental operating cost, contingencies, agency fee and charges. /c Other sources of financing include self financing by enterprises and commercial loans.  - 11 - Schedule B CHINA THIRD ODS PHASEOUT PROJECT PROPOSED PROCUREMENT ARRANGEMENTS AND ESTIMATED DISBURSEMENT SCHEDULE PROPOSED PROCUREMENT ARRANGEMENTS 1. The procurement procedure for one-time capital costs will follow CIB's practices, considered satisfactory to the Trustee. It will be substantially similar to other environmental projects in China, consisting at a minimum of the following: Goods (a) Contracts over $2 million equivalent (excluding proprietary packages) would be procured under ICB procedures (estimated to be around 20 percent of Grant amount); (b) Contracts of $2 million or below and above $250,000 would be awarded on the basis of evaluation and comparison of quotations solicited from at least three qualified suppliers and from at least two countries; (c) Contracts below $250,000 would be procured on the basis of comparison of price quotations solicited from at least three qualified suppliers; and (d) Proprietary items would be procured by direct contracting. Consultants Consultants shall be engaged on the basis of the "Guidelines for the Use of Consultants by World Bank Borrowers and the World Bank as Executing Agency" dated August 1981. 2. All ICB contracts, proprietary items and all consultancy contracts in excess of $100,000 for firms and $50,000 for individuals would be subject to the Trustee's prior review. ESTIMATED DISBURSEMENT SCHEDULE ($ million) Bank Fiscal Year FY96 FY972 EY9Y99 FY2000 Annual 20.1 21.5 26.5 15.0 7.0 Cumulative 20.1 41.6 68.1 83.1 90.1  - 12 - Schedule C CHINA THIRD ODS PHASEOUT PROJECT TIMETABLE OF KEY PROJECT PROCESSING EVENTS Preparation (time taken): 12 months Prepared by: NEPA and the Bank First Presentation to the Bank: November 1993 Departure of Bank Appraisal Mission: October 26, 1994 Date of Negotiations: March 1995 Planned Date of Signing: June 1995 Planned Date for Effectiveness: August 1995 List of Relevant PCRs and PPARs: None Planned Completion Date: December 31, 1999 The project was prepared by the following: H. Chan (Operations Officer, task manager), D. Brown (Principal Industrial Specialist), L. U. Hale (Operations Officer), and C. Catanach (Consultant). The Division Chief is Richard S. Newfarner and the Department Director is Nicholas C. Hope.  -13 - ANNEX 1 SUMMARY OF CHINA COUNTRY PROGRAM FOR THE PHASEOUT OF OZONE DEPLETING SUBSTANCES UNDER THE MONTREAL PROTOCOL Strategy 1. The Government of China will strictly adhere to the provisions of the Montreal Protocol and undertake necessary measures for the phaseout of ozone depleting substances (ODS) production and consumption in China by the year 2010, provided that sufficient funds are made available and needed technologies are transferred in accordance with the provisions of the Protocol. China will speed up its ODS phaseout once cost-effective substitute technologies and sufficient financial assistance for implementing the technical changeover are obtained. ODS Situation in China 2. China's ODS consumption in 1991 was 48,239 metric tons (mt), of which 63 percent was produced domestically and 37 percent was imported. Seven types of ODS controlled by the Montreal Protocol are commonly produced and used in China: CFC- 11, 12 and 113; halon-1211 and 1301; carbon tetrachloride (CTC); and methyl chloroform (TCE). The four substances accounting for most of the total ODS in 1991 were CFC-12 (48 percent), CFC-l 1 (34 percent), Halon-1211 (8 percent), and CFC-1 13 (8 percent). 3. In terms of ODS, the foams sector is the largest user in China, accounting for 37 percent of total consumption, followed by the refrigeration and air-conditioning sector with 27 percent, aerosols with 18 percent, solvents with 10 percent, and fire extinguishing (halons) with 8 percent. Although halon usage is relatively small, halons have significant impact due to their greater weighted ozone depletion potential, and therefore merit special attention. Forecast of Unconstrained ODS Demand to the Year 2010 4. China's economy is growing rapidly, and ODS consumption is expected to increase at about 11 percent annually. ODS consumption, if not controlled, is expected to reach 84,000 mt by 1996, 116,900 mt by 2000, 173,700 mt by 2005, and 255,600 mt by 2010. Projected ODS consumption in 2010 can be broken down as follows:  -14 - ANNEX 1 - CFC-11: 35,500mt -Halon-1211: 19,200 mt - CFC-12: 138,500 mt |- Halon-1301: 900 mt - CFC-113: 45,600 mt| - CTC: 3,100 mt - TCE: 12,900 mt l 5. Projected increases in ODS demand will span all sectors. Demand for rigid polyurethane (PU) foams used in domestic refrigeration is expected to increase at an annual rate of 8 percent until 1995 and at a rate of 3 percent after 1995. Demand for other foams should increase at a rate of 6 percent per year. Industrial refrigeration and air-conditioning are expected to increase steadily at 8 percent per year, while commercial refrigeration is projected to grow at 18 percent per year up to the year 2000 and 15 percent per year thereafter. Mobile air-conditioning (MAC) demands are expected to grow at an annual rate of 20 percent before 2000 and 10 to 12 percent after 2000. 6. Demand for Halon- 1211 fire extinguisher is expected to grow by 11 percent before 1997 and by 7 percent after 1997, and for extinguishing systems by 14 percent until 1997 and by 12 percent per year thereafter. Demand for Halon- 1301 systems is expected to grow by 20 percent before 1997 and by 15 percent after 1997. 7. Demand for aerosols is expected to increase at 30 percent per year until 1995, at 9 percent during 1996-2000, and at 6 percent during 2001-10. Solvents used in electronics cleaning are expected to experience a demand growth rate of 11 to 16 percent through the year 2010. Institutional Framework 8. The Government of China has established a formal national institutional framework for ozone layer protection and for implementation of the Montreal Protocol. Within this framework, the Leading Group for Ozone Layer Protection is responsible for the implementation of Vienna Convention and Montreal Protocol provisions, the review of various implementation options, and strategic decision-making. The Leading Group comprises the National Environmental Protection Agency (Leader), the Ministry of Foreign Affairs, State Planning Commission, State Science and Technology Commission, and MOF (vice-leaders), and eight current members (seven ministries' and the General Administration of Customs). Members of the Leading Group on Ozone Layer Protection include the Ministry of Commerce (MOC), National Council of Light Industry (NCLI), Ministry of Public Security (MPS), Ministry of Aerospace Industry (MAI), Ministry of Chemical Industry (MCI), Ministry of Machinery Industry (MMI), and Ministry of Foreign Trade and Economic Cooperation (MOFTEC) and China National Tobacco Cooperation (CNTC). The Ministry of Agriculture is also proposed as a member.  -15 - ANNEX 1 9. Three other entities report to the Leading Group: the Coordinating Group for Ozone Layer Protection, eight technical Sectoral Working Groups, and the Center for Environmental Sciences at Beijing University. The Coordinating Group has been entrusted with the following tasks: (a) concrete implementation of the Convention and the Protocol; (b) coordination of the production, import, export and consumption of controlled substances and their products; (c) financial analysis of the domestic and external funding needed for implementation of the Protocol; (d) proposing various options to the Leading Group; and (e) handling other affairs related to the Convention and the Protocol. 10. The Sectoral Working Groups formulate sectoral components of the Country Program as well as specific projects. The Working Groups represent aerosols, chemical substitutes, foams, halons, ODS recycling and recovery, refrigeration/AC/MACs. refrigerator manufacture, and solvents. The Center for Environmental Sciences at Beijing University is responsible for updating the Country Program. 11. Other institutions involved include the State Administration of Commodity Prices, which manages the prices of controlled substances and substitute technologies, and local environmental protection agencies, which are responsible for the implementation of environmental regulations at the local level. Policy Framework 12. China's policy framework to phase out ODS and encourage the use of substitute technologies consists of the following 10 specific policies: (a) Production Management. A permit and quota system will be used to manage ODS production. Govermment permission will be required for ODS manufacture, based on environmental impact assessments. Enterprises must follow the ODS phaseout schedule in the Country Program. (b) Imports. Imports of ODS and their products will be restricted in order to promote local production of ODS substitutes. (c) Prices. Prices of ODS and ODS substitutes will be adjusted when appropriate to ensure a smooth transition. (d) Sales. Government will be the exclusive supplier for sales of ODS.  -16 - ANNEX 1 (e) Taxation. Tax rates on ODS and their products will be controlled or increased. Tax reductions/exemptions will apply to ODS substitutes and ODS recovery. (f) Investment. The government will encourage investment policies that promote ozone protection. (g) Incentives. The government encourages the development of technologies for ozone protection applicable to China, and will establish a fund for outstanding contributors to ODS phaseout. (h) Public Awareness. Public media resources will be used to raise public awareness of ozone issues. Technical training courses will increase skills of technicians and managers involved with ODS. (i) Green Labels. "Green labels" will be issued to products made with non- ODS and ODS substitutes. (j) Legal Policy. Regulations for managing ODS and ODS substitutes will be enhanced and finalized. Government and Industry Responses to the Protocol 13. China has already issued bans on new ODS-based production facilities in the fire protection and aerosol sectors (1990 and 1991, respectively). Other government and industry responses to the Protocol to date include the establishment of a state-level institutional framework and Ministry-level administrative institutions; the elaboration of industrial management systems for compliance; research into substitution technologies; the mobilization of funding for loans; the establishment of an assessment center for CFC substitution; various activities for the exchange of technical and policy information; and the publishing of various papers to raise public understanding. ODS Phaseout Implementation 14. The ODS phaseout implementation schedule is shown in the following table: Sector Description Phaseout date Aerosols Excludes medical applications 1997 Foams Excludes use in refrigerators and hard polyurethane boards 2000 Chemical substitutes Excludes Halons 2010 Industrial/commercial refrigeration 2005 Domestic Refrigeration Includes use in refrigerators and hard polyurethane boards 2000 Halons 2000L& Solvents n.a.L ODS recovery and recycling Construction of recovery/recycle networks/sites 2005 da Not completely phased out. By the year 2000, halons will be phased out for nonessential uses, production of halon and halon extinguishers will be halted, and halon storage and recycling equipment will be reinforced for storage of halons for essential uses, a Promotion of non-ODS technologies through entire industry will be started in 1996. It is difficult to predict complete phaseout.  -17- ANNEX 1 ODS Phaseout Costs 15. The current least-cost option for phasing out ODS in China by 2010 is estimated to have a direct net incremental cost of about $1.4 billion (not yet endorsed by MPEC). Other incremental costs have not yet been calculated. The net administrative/management costs for implementation of the Government's Action Plan to implement the proposed strategy is $500,000 per year.  -18 - ANNEX 2 DESCRIPTION OF SUBPROJECTS IN THE FIRST AND SECOND TRANCHES (Approved by MPEC in June and December 1994) FIRST TRANCHE SUBPROJECTS Foam Subsector 1. Shanghai No. 6 Plastics Product Plant (Shanghai #6) Shanghai #6 was the first plant in China to produce rigid pipe/spray insulation. Consumption of CFCs is 660 tons. The objectives of the project are (a) to phase out the use of CFCs in production of rigid polyurethane (R-PUF) pipe/spray insulation at Shanghai #6, and (b) to make Shanghai #6 a commercial demonstration for phaseout of CFC-1 1 in pipe insulation. To prepare for this project, representatives of Shanghai #6, NCLI and NEPA went to Europe in September 1993 to look for technologies that could phase out the use of CFC- 11 in PUF pipe insulation. After evaluating the different technologies, they chose the "water blown" as a main option. However, this option will need time for formulators to optimize recipes and engineers to adjust production process to ensure the quality of foams produced be the same as the original ones. HCFC-141b was selected as an interim solution for those formulations that are not yet successfully optimized. All technologies evaluated need high-pressure dispensing machines that allow processing of higher viscosity of the polyol after elimination of a physical blowing agent and improve the K-value through a more regular, consistent, finer cell structure. In addition, the elimination of flushing, higher efficiency and less product scrap will partially offset increased costs generated by using the "water blown" technology and HCFC-141b option. 2. Shanghai No. 18 Plastics Product Plant (Shanghai #18) Shanghai #18 was the first plant in China to produce extruded polyethylene and extruded polystyrene (EPE/EPS) foam sheets. The objective of this project is to phase out the use of CFCs in the production of EPE/EPS foam sheets at Shanghai #18. Pentane was selected as the preferred replacement in this project. Applicable technologies are available from original equipment manufacturers and companies specialized in retrofitting. In addition to equipment retrofitting, safety-related modifications in the production environment will be implemented to mitigate fire and exposure hazards. Finally, extensive production and safety training will be undertaken to guarantee smooth and safe operations and to conform to the fire safety standards in China. Butane will be used as a backup blowing agent and will be used only when supply of pentane is interrupted. The investment  -19- ANNEX2 cost will not be affected by the possible use of butane because equipment retrofitting, safety modification and training for using pentane and butane are similar. Aerosol Subsector 3. Zhongshan Fine Chemical Industrial Ltd. (Zhongshan) Zhongshan was established in 1982 and uses manufacturing technology developed by the enterprise itself to produce aerosol products, aerosol cans (including valves) and fine chemical products. In 1992, aerosol output at Zhongshan reached 48.8 million cans, which was about 30 percent of the national output. The consumption of CFC-12 in 1992 was 2,250 tons, of which about 70 percent was used in hair sprays and air fresheners. The objective of the project is to phase out CFC-12 by (a) setting up facilities with an annual output capacity of 5,000 tons for manufacturing dimethyl ether (DME) as a substitute for CFC-12; and (b) retrofitting aerosol filling centers with filling capacity of 35 million cans/year. The enterprise has signed an agreement on the technology of making DME by methanol with the Southwest Research Institute of the Ministry of Chemical Industry to take over its scientific research result and designs for this project. Technology and equipment for DME manufacturing facilities are basically from China, the main hardware of computer system will be imported from Japan and the United States. The Center retrofitting process includes installation of a gassing room, safety devices, ventilation, alarming and fire extinguishing, etc. Domestic Refrigeration Subsector 4. Shanghai Refrigeration Compressor Co. Ltd. (Shanghai Compressor) Shanghai Compressor supplies a variety of refrigerator compressors to a number of refrigerator companies in China. In 1993, 550,000 compressors were produced, about 10 percent of China's total requirement. The objective of this project is to provide an indigenous source of Mitsubishi HFC-134a rotary compressors for use with new model refrigerators based on HFC-134a refrigerant at Shanghai Shangling General Refrigerator Factory. This project will result in the annual production of up to 500,000 high-efficiency rotary HFC-134a compressors to supply the needs of the Shanghai Shangling General Refrigeration Factory and others as they introduce HFC-134a refrigerant into their line of refrigerators. Technology will be obtained from Mitsubishi (Japan) under the terms of an existing technology transfer agreement. The project will convert manufacturing of domestic refrigerator compressor manufactured from CFC- 12 designs to a newly developed rotary compressor suited to HFC-134a refrigerant at Shanghai Compressor. The project will be conducted in two Phases: (a) Phase I. Engineering, product development and testing under local conditions to integrate new Mitsubishi technology and to establish basic data for full conversion of the factory to make the new rotary compressors.  - 20 - ANNEX2 (b) Phase II. Full conversion of the Shanghai Compressor to Mitsubishi HFC-134a rotary compressor designs. 5. Shanghai Shangling General Refrigerator Factory (Shangling) Shangling produces refrigerators, air conditioners, microwave ovens and other domestic appliances. The factory has one production line imported from Mitsubishi (Japan). The line is capable of producing 500,000 refrigerators annually based on two-shift operation. Eight models are produced, with about 1 percent of the refrigerators produced exported. In 1992, Shangling produced 11 percent of the refrigerators sold in China. The objective of this project is to establish a phased introduction of proven and useful technology for HFC-134a refrigerant in rotary compressors in China. The results of this project will be evaluated and considered for adoption by similar refrigerator operations in China. The project will accomplish phaseout of CFC-12 used as refrigerant in domestic refrigerators produced by Shangling in two phases: (a) Phase I. Engineering, product development and testing under local conditions to establish basic data for full conversion to HFC-134a and for comparison with results of similar programs using alternative refrigerants. (b) Phase II. Full conversion of the Shangling facilities to HFC-134a refrigerant. 6. Hua Yi Electrical Appliance General Company (Hua Yi) Hua Yi produces household electric appliances, air conditioners and freezers and has one production line that was imported from Merloni (Italy) in 1985. The line is capable of producing 300,000 refrigerators annually, based on two-shift operations. Sixteen models are produced. About 10 percent of refrigerators produced are for export. In 1992, Hua Yi produced 6 percent of the refrigerators sold in China. The objective of this project is to establish a phased introduction of technology for use of HFC-1 34a in domestic refrigerators equipped with new reciprocating compressors and produced by Hua Yi. The project will develop reliable data for comparison with other refrigerant projects. The results of this project will be evaluated and considered for adoption by similar refrigerator operations throughout China. The project will accomplish phaseout of CFC-12 used as refrigerant in domestic refrigerators produced by Hua Yi in two phases: (a) Phase I. Engineering, product development and testing under local conditions to establish basic data for full conversion to HFC- 1 34a refrigerant has been completed. (b) Phase II. Full conversion of the Hua Yi factory to HFC- 1 34a refrigerant.  - 21- ANNEX2 7. Wanbao Electrical Appliance Industrial Corporation (Wanbao) Wanbao first produced refrigerators in 1980 with the models from Acme in Singapore and Hitachi in Japan, but has subsequently developed its own designs. It uses domestically produced compressors. Wanbao Group has a number of subsidiaries and produces refrigerators, freezers, air conditioners, compressors, washing machines, rice cookers and other electrical appliances. It has six refrigerator production lines. These are capable of producing 1.2 million refrigerators in two shifts. Approximately 40 percent of production is exported (80 percent of all refrigerators exported from China). Most are sold in the United States, with a significant number sold in France. Wanbao's share of the domestic market is about 5 percent. The project will phase out CFC-12 used in household refrigerators manufactured at Wanbao. The project will accomplish phaseout of CFC-12 used as refrigerant in domestic refrigerators produced by Wanbao in two phases: (a) Phase I. Engineering, product development and testing under local conditions to establish basic data for frill conversion to HFC-152a and for comparison with results of similar programs using alternative refrigerants. (b) Phase II. Full conversion of the Wanbao factory to HFC-] 52a refrigerant. 8. Chang Ling (Group) Co. Ltd. (Chang Ling) Chang Ling produces household electric appliances, textile, military and domestic electronics. It has four research institutes and one production line imported from Merloni (Italy) in 1987. The line is capable of producing 400,000 refrigerators annually based on one-shift operation. Thirty models are produced, with export of about 3 percent of the refrigerators produced. In 1992, Chang Ling produced 6 percent of the refrigerators sold in China. The objective of this project is to establish a phased introduction of technology for use of HFC-152a/HCFC-22 blended refrigetant in domestic refrigerators produced by Chang Ling. The results of this project will be evaluated and considered for adoption by similar refrigerator operations. The project will accomplish phaseout of CFC-12 used as refrigerant in domestic refrigerators produced by Chang Ling in two phases: (a) Phase I. Engineering, product development and testing under local conditions to establish basic data for full conversion to HFC-1 52a/HCFC-22 blended refrigerant and for comparison with results of similar programs using alternative refrigerants. (b) Phase I1. Full conversion of Chang Ling to HFC-152a /HCFC-22 blended refrigerant.  - 22 - ANNEX2 9. Shanghai Shuanglu Electrical Appliances Co. Ltd. (Shuanglu) Shuanglu produces refrigerators, freezers, and other household appliances. There are four refrigerator lines capable of producing 400,000 refrigerators on a two-shift basis. Three primary models are produced. About 5 percent of the refrigerators produced are exported. In 1992, Shuanglu produced 7 percent of the refrigerators sold in China. The objective of this project is to establish a phased introduction of technology for use of HCFC-22/HFC-152a/HCFC-124 ternary blend refrigerant (MP-39) in domestic refrigerators produced by Shuanglu in order to develop reliable data for comparison with other alternative refrigerants. The results of this project will be evaluated and considered for adoption by similar refrigerator operations in China. The project will accomplish phaseout of CFC-12 used as refrigerant in domestic refrigerators produced by Shuanglu in two phases: (a) Phase I. Engineering, product development and testing under local conditions to establish basic data for full conversion to HCFC-22/HFC- 152a/HCFC-124 (MP-39) ternary blended refrigerant and for comparison with results of similar programs using alternative refrigerants. (b) Phase II. Full conversion of the Shuanglu factory to MP-39 refrigerant. Halon Subsector 10. Tongxiang Chemical Fertilizer Factory Tongxiang Factory was commissioned in June 1988 and currently produces 368 tons of Halon- 1211 per year. Its annual production capacity of 400 mt accounts for almost 10 percent of total Halon-121 1 production in China. The objective of this project is to eliminate its production of Halon-1211 by dismantling and demolishing the Halon-1211 production facilities at Tongxiang Chemical Fertilizer Factory. Total project cost will be composed of the following items: (c) the cost of dismantling halon production facilities and workshop buildings less a small amount of scrap value for materials; (d) the financial losses of the factory by the shutdown of the halon production: Since Halon-1211 is a profit-making product, the company is asking compensation for profit loss for the remaining life of the production line; and (e) the compensation to the staff and workers of the halon production workshop: This is to compensate staff and workers for salary loss and need for retraining for other jobs.  - 23 - ANNEX2 SECOND TRANCHE SIJBPROJECTS Foam Subsector 11. Henan Zhengzhou Plastics Products Plant This project will phase out 260 mt CFC-11/12 used to produce extruded polyethylene and polystyrene foams (EPE/EPS) through the use of butane blowing agent at Zhengzhou Plastic Products Plant. Zhengzhou is a 100 percent state-owned enterprise and has a 12 percent share of the EPE/EPS market. Direct savings in operational costs resulting from the lower price of butane have been deducted from the estimated incremental capital costs for this project. Incremental capital costs include extruder and other retrofitting plus training of workers for safe use and handling of butane. The project will be completed within one year of authorization. 12. Lanzhou Plastics Packing Material Factory This project will phase out 200 mt CFC-12 used to produce extruded polyethylene and polystyrene foams (EPE/EPS) through the use of butane blowing agent at Lanzhou Plastic Packing Material Factory. Lanzhou is a 100 percent state-owned enterprise and has a 10 percent share of China's EPE/EPS market. Direct savings in operational costs resulting from the lower price of butane have been deducted from the estimated incremental capital costs for this project. Incremental capital costs include extruder and other retrofitting plus training of workers for safe use and handling of butane. The project will be completed within one year of authorization. 13. Cangzhou No. 2 Plastics Plant This project will phase out 140 mt CFC-12 used to produce extruded polyethylene and polystyrene foams (EPE/EPS) through the use of butane blowing agent at Cangzhou No. 2 Plastic Plant. Cangzhou No. 2 is a 100 percent state-owned enterprise and has a 7 percent share of China's extruded EPE/EPS market. Direct savings in operational costs resulting from the lower price of butane have been deducted from the estimated incremental capital costs for this project. Incremental capital costs include extruder and other retrofitting plus training of workers for safe use and handling of butane. The project will be completed within one year of authorization. 14. Hebei Dongfeng Plastics Plant This project will phase out 110 mt CFC-1 I used to produce polyurethane flexible foam through the use of water/methylene chloride blowing agent and accelerated cooling at the Dongfeng Plastic Plant. Dongfeng is a 100 percent state-owned enterprise. The project requests only incremental capital costs for an accelerated curing unit, a metering and storage system, improved ventilation, and safety training. There will be no incremental operating costs or savings. The project will be completed within one year of authorization.  - 24 - ANNEX2 15. Zhangjiangang Gaofeng Polyurethane Plastics Plant This project will phase out 180 mt CFC-1 I used to produce polyurethane flexible foam through the use of water/methylene chloride blowing agent and a fast curing system at the Gaofeng Plastic Plant. Gaofeng is a 100 percent state-owned enterprise. The project requests only incremental capital costs for a fast cure unit, a metering and storage system, improved ventilation and safety training. There will be no incremental operating costs or savings. The project will be completed within one year of authorization. 16. Beijing Foam Plastics General Factory This project will phase out 100 mt CFC-I I used to produce polyurethane flexible slab-stock foams through the use of water/methylene chloride blowing agent and an accelerated cooling system at the Beijing Foam Plastic General Factory. Beijing Foam is a 100 percent state-owned enterprise. This project requests only incremental capital costs for an accelerated curing system, a metering and storage system, improved ventilation, and safety training. There will be no incremental operating costs or savings. The project will be completed within one year of authorization. Commercial Refrigeration Subsector 17. Beijing Refrigerating Machinery Factory This project will phase out CFC-12 consumption in the production of medium-size semihermetic compressors at Beijing Refrigerating Machinery Factory by converting the production to HCFC-22 compressors. The enterprise will introduce advanced medium semihermetic compressor technology from abroad. After that the enterprise will convert its semihermetic compressor production line to the production of HCFC-22 compressors. It is estimated that on average the type of systems on which these compressors are used lose 100 percent of their charge in leaks in later years. Since the amount of CFC-12 used in the initial charge of these systems totals about 145 tons, a further 145 tons leakage loss will be saved, giving a total annual reduction in CFC- 12 use of 290 tons per year when the plant is at full capacity. This project employs commercially available and mature technology in one of the country's largest CFC use sectors. 18. Shanghai Refrigerating Machine Works This project will phase out CFC-12 consumption in the production of medium-size open-type compressors at the Shanghai Refrigerating Machine Works by converting the production to H-ICFC-22 based compressors. It is estimated that on average the type of systems on which these compressors are used lose 100 percent of their charge in leaks per year. When the plant is at full capacity, it is expected that total annual reduction in CFC-12 use will be 200 tons per year. The project employs commercially available and mature technology in one of the country's largest CFC use sectors.  - 25 - ANNEX2 19. Nanjing Refrigerator General Works This project will phase out CFC-12 consumption in the production of small semihermetic type compressors of 1-5 kW capacity at the Nanjing Refrigerator General Works by converting the production to HCFC-22 based compressors. It is estimated that on average the type of systems on which these compressors are used lose 100 percent of their charge in leaks per year. When the plant is at full capacity, it is expected that total annual reduction in CFC-12 use will be 285 ODP-equivalent tons per year. This project employs commercially available and mature technology in one of the country's largest CFC use sectors. 20. Jiangsu Taizhou Commercial Machinery Factory This project will gradually phase out CFC-12 in the production of small semihermetic refrigeration compressors at the Jiangsu Factory and convert production to HCFC-22 small semihermetic compressors. This project employs commercially available and mature technology in one of the country's largest CFC use sectors. The enterprise is 100 percent state-owned and is the largest producer of semihermetic compressors in China. 21. Anhui Refrigerating Machinery Factory This project will phase out CFC-12 consumption in the production of small semihermetic compressors at the Anhui Provincial Refrigerating Machinery Factory by converting the production to HCFC-22 based compressors. The enterprise is 100 percent state-owned. This project will gradually phase out CFC-12 in the production of small semihermetic refrigeration compressors at the Anhui Factory and convert production to HCFC-22 small semihermetic compressors. This project employs commercially available and mature technology in one of the country's largest CFC use sectors. 22. Yantai Refrigerating Machinery Works This project will partially substitute CFC-12 consumption in medium- and low- temperature commercial refrigeration equipment (12-72 kW capacity) by the production of small ammonia compressors and ancillary equipment. When the plant has reached full capacity, 3,200 small ammonia compressors and ancillary equipment will be produced and 240 tons of CFC-12 will be phased out annually. The objective of this project is to import mature foreign technology for the manufacture of small ammonia compressors and related ancillary equipment.  - 26 - ANNEX3 SUBPROJECT ELIGIBILITY AND OPERATIONAL MECHANISMS A. PROJECT COORDINATION AND MANAGEMENT 1. Overall Responsibilities. The Project Management Office (PMO) in NEPA will have responsibility for ODS Country Program implementation and will ensure that ODS subprojects are consistent with the Country Program. The PMO will contract out technical appraisals, coordinate preparation of sector strategy studies and identification of subprojects, supervise the financial agent(s), ensure that subproject implementation corresponds to MPEC approval, prepare Project progress and completion reports, ensure compliance with environmental regulations and oversee preparation of audit reports. The China Investment Bank (CIB) is the financial agent. It will be responsible for preparation of subproject appraisal reports (it will carry out the financial and economic appraisals and incorporate technical appraisals into the appraisal reports), and subproject supervision (including procurement and disbursement of grants to participating enterprises, and preparation of subproject progress and completion reports). It will administer funds allocated by the Bank from the OTF to the subprojects. B. StJBPROJECT ELIGIBILITY AND APPRAISAL CRITERIA 2. Subproject Eligibility. Subprojects should: (a) be confirmed by NEPA/PMO as essential to Country Program objectives; (b) have a direct, demonstrable result in reducing ODS consumption and production; (c) be cost effective and based on environmentally sound technologies (in compliance with national environmental regulations); (d) adopt substitutes (or recycling) for substances controlled by the Montreal Protocol, taking into account national industrial policy; and (e) be financially viable. OTF funding is based on grants to enterprises (or agencies) implementing subprojects. 3. Subproject Priority and Unit Abatement Cost. Subprojects with the most cost- effective technology and with the lowest unit abatement cost (UAC) of ODS in the shortest period of time in terms of global impact should receive priority. Relative cost effectiveness is measured by UAC, a comparative index defined as: A = C(F + (OC-OS w CIB is the proposed financial agent now. Other eligible financial institutions may be identified during project implementation. All financial agents will bear the same responsibilities and receive the same compensation (i.e., 2 percent of subgrant amounts).  - 27 - ANNEX3 where A = unit abatement cost, $/kg ODP saved/year (at full operation) C = Incremental capital cost, including all initial one time costs (technology, equipment, materials and training) F = Capital recovery factor; the annualized capital cost charges, discounted at a standard discount rate of 10 percent per year, over the economic life of the project OC = Annual Operating Costs at full operation OS = Annual Operating benefits/savings at full operation W = Quantity of ODS saved annually expressed as ODP units The purpose of UAC calculation is to give a relative ranking of projects across countries and within the same sector and taking economies of scale and other factors into consideration. Lower unit abatement costs correspond to higher priority in terms of cost effectiveness. The UAC is calculated at standard discount rates to facilitate cross-country comparisons. It should be noted, however, that UAC is only one indicator of cost effectiveness for ODS phaseout projects. Other considerations, such as cumulative ODS savings, are also important indicators. Smaller subprojects are expected to have a relatively higher UAC. 4. The criteria for financial viability of enterprises shall include an evaluation of the beneficiary enterprises' financial viability, as measured by a debt service coverage ratio of no less than 1.2 times after subproject completion and upon attainment of full production capacity. 5. Incremental costs of subprojects eligible for OTF funding are defined according to Trustee and MPEC guidelines; and these include (a) capital costs (excluding import duties and excise taxes), and (b) any eligible incremental operating costs. 6. Policy Considerations. Overall economic/industrial policy reforn is excluded from consideration by MPEC guidelines. The China ODS Country Program will address policies required to develop and implement China's ODS phaseout program. Policies that directly affect successful implementation of a subproject should be addressed before the subproject is submitted to MPEC. 7. Ownership. A subproject is eligible for funding in direct proportion to local ownership of a percentage of the enterprise, including ownership from other eligible Article 5 countries. 8. Taxes. Taxes (import, excise, etc.) are not eligible for reimbursement. The effect of taxes on the subproject financing requirements should be addressed in the Project Summary.  - 28 - ANNEX3 C. OPERATIONAL GUIDELINES 9. Subproject Preparation. The respective enterprise is responsible for preparation of its ODS phaseout subproject including feasibility study and Project Summary, showing the portion of project costs eligible for OTF financing. Selected enterprises may be assisted in project preparation under a Project Preparation Advance. The Bank may also assist in project preparation, focusing on technology, eligibility criteria and implementation and reporting requirements. A preliminary review by the Ozone Operation Resource Group (OORG) is recommended at this stage. 10. Review within China. NEPA/PMO will coordinate all subproject reviews and obtain agreements with relevant ministries and international implementing agencies. The work includes ensuring consistency with the ODS Country Program, with eligibility guidelines for OTF financing, and with other Government guidelines. The Bank's technical consultants will assist, in parallel, in ensuring that subprojects are consistent with OTF requirements. Prior to NEPA's endorsement of the subprojects, the financial agent(s) will confirm the financial viability of the enterprises. The final local approval is made by NEPA/PMO. 11. Review within the Bank. The Bank's review and approval of subprojects, including review by OORG, will proceed in parallel with NEPA/PMO review. (a) For subprojects over $500,000. OORG approval will be obtained prior to submission of subproject proposals to MPEC, and the Bank will ensure consistency with MPEC eligibility. The Bank will submit the proposals to MPEC for approval and funding. (b) For subprojects under $500,000. The Bank/OORG will review technology and cost effectiveness. The Bank will submit these proposals to MPEC for funding as part of the Bank's ODS work program. 12. Review by MPEC. MPEC will review and approve subprojects, based on the Indicative List of Eligible Items and MPEC's guidelines for project funding. (a) For subprojects over $500,000. MPEC will review, approve and fund under its established procedures. (b) For subprojects under $500,000. MPEC will approve as part of the Bank's ODS work program submission. 13. Subproject Appraisal. The financial agent(s) will appraise the subprojects, taking into full consideration that the preappraisal, approval, and funding has already been completed by NEPA, the Bank, and MPEC with respect to subproject costs and technical aspects. Review of technical feasibility will in almost all cases have already been completed by the OORG review process. Appraisal work (or in most cases only confirmation) should include:  - 29 - ANNEX3 (a) Project Scope. Divided into: (i) component relating to ODS phaseout and (ii) other components, such as expansion or upgrading. Review of the technical feasibility of a subproject should be undertaken to determine the soundness of the proposal; (b) Schedule and Quantity of ODS phaseout directly attributed to subproject, on an annual and total basis; (c) Project Costs. Divided into: (i) components relating to ODS phaseout and (ii) other components. Foreign exchange and local costs should also be shown; (d) Economic and Financial Analysis of Subprojects. For all subprojects, calculation of the financial rate of return (FIRR) to determine financial viability is required. For subprojects with grants of more than $500,000, calculation of the economic rate of return (EIRR) to determine economic viability of subprojects will also be needed. (e) Financial Analysis of Beneficiary Enterprises. This analysis includes: (i) financial evaluation of the enterprises in the past three years with a few agreed financial indicators to demonstrate financial viability; and (ii) financial projections for the future three years. The enterprises are required to maintain a minimum debt service coverage ratio of 1.2 times to ensure financial health and show that they will be able to implement the subprojects successfully; (f) Financing Plan. Divided into (i) incremental costs related to ODS phaseout to be financed as OTF grant, (ii) amount to be provided by enterprise from its own resources, and (iii) commercial loans. The plan should be shown and confirmed; (g) Project Implementation Arrangements including management, engineering and technology acquisition, procurement, installation, operation, marketing and implementation schedule should be provided. Procurement and consultant selection procedures should be consistent with relevant Bank Guidelines applicable for financial intermediary operations in the country. A disbursement schedule should be given; and (h) Environmental and Fire Safety Aspects of the subproject should be documented and the financial agent(s) and/or NEPA/PMO will ensure that the subproject complies with local regulations. Both EAs and safety reports should be approved by local environment and fire protection bureaus prior to project implementation.  - 30 - ANNEX3 14. Subgrant Agreement. The Subgrant agreement between the financial agent(s) and each enterprise will follow a model subgrant agreement approved by the Trustee, including enterprise obligation regarding ODS phaseout. 15. Disbursement. Disbursements would be according to Bank guidelines: (a) Disbursement of Agreed Incremental Operating Costs would be based on total operating costs for actual performance over the first 1-4 years of operation, or until the full amount of eligible funding is disbursed. For subprojects requiring funding for profits forgone from premature closure of ODS production facilities, disbursement of agreed funding will be against: (i) total investment costs for replacement facilities; (ii) total operating costs for existing facilities of the enterprise that will continue to operate after closure, or (iii) if neither (i) or (ii) apply, physical cost of demolishing the facility and actual total production costs for the last 2-3 years of operations of the facility being closed. (b) Between Bank and the Financial Agent(s). On Grant effectiveness and receipt of a withdrawal application from the financial agent(s), the Bank will make a deposit of up to $3 million into a Special Account. The authorized ceiling of the Special Account is $5 million. Replenishment of this Special Account and all other disbursements would be made against full documentation except for expenditures (i) under contracts valued below $2,000,000, (ii) for all consultancy contracts below $100,000 for firms and $50,000 for individuals, and (iii) training, agency fees and charges, for which the Bank will accept Statements of Expenditures (SOE) under the disbursement category for subgrants. Supporting documents for SOEs, including contracts, procurement documentation, and evidence of payment, should be kept by the PMO (technical assistance for PMO component) and the financial agent(s) (subgrants, technical assistance for the financial agent(s), and unallocated components) for examination by independent auditors and Bank supervision missions. The Special Account will be replenished monthly or whenever it is drawn down to 50 percent of its initial deposit, whichever occurs first. The Bank will accept application for direct payment and issuance of a special commitment (outside the Special Account) only above a minimum amount of $1,000,000. A disbursement letter will be issued after the Grant is signed. (c) Between Financial Agent(s) and Subproject. The financial agent(s) will disburse to the subproject proponent for eligible expenses according to disbursement procedures acceptable to the Bank. Incremental operating costs will be calculated on actual total operating costs and benefits, based on annual operation statements prepared by the enterprises to be approved by NEPA, the financial agent(s) will then disburse the incremental operating  - 31- ANNEX3 costs to the enterprises over the first 1-4 years (but in almost all cases over the first 1-2 years) of operation of the subprojects. 16. Procurement. The financial agent(s) will be responsible that procurement under the Project follows agreed guidelines (Schedule B). The financial agent(s) will supervise procurement for packages in each subproject, using the Bank standard bidding documents. 17. Subproject Implementation. Each enterprise will be responsible for subproject implementation. For that purpose, it will sign a subgrant agreement with the financial agent(s) that will spell out responsibilities of enterprise and its commitment to undertake the necessary activities agreed upon in the subproject proposal to achieve the intended ODS reduction or phaseout. 18. Subproject Supervision. CIB will have prime responsibility for supervising implementation of subprojects while it is still disbursing to the subprojects. CIB responsibility for subproject supervision ends after full disbursement and approval of the subproject completion report by NEPA and the Bank. NEPA/PMO will monitor progress of subprojects in fulfillment of its overall responsibility for implementation of the ODS Country Program. 19. Reporting Requirements. (a) Semiannual and Annual Progress Reports. NEPA and CIB or other financial agent(s) will prepare different sets of progress- reports for submission to the Bank. CIB will submit these reports to the PMO for transmittal to the Bank, covering the status of subgrant disbursements and progress of the subprojects until the Grant is fully disbursed. The set of reports to be prepared have been agreed. In cases where incremental operating costs are to be financed under the Grant, the enterprise would submit a progress report to CIB prior to each payment; and (b) Audits. NEPA will appoint an independent auditor acceptable to the Bank to prepare audit reports. The audit of the project account would be a project- specific financial statement with details on cash receipts and disbursements for the Project for the year and on a cumulative basis. Audit reports would include all project components, Special Accounts and SOEs. All audits should be submitted to the Bank within six months after the end of the financial agent(s)' fiscal year.