Project Performance Audit Report

PPA: PRC 25023

(Final)

Tangshan and Chengde Environmental Improvement Project in Peoples Republic of China (Loan 1270-PRC)

December 2004

Operations Evaluation Department

Asian Development Bank

CURRENCY EQUIVALENTS Currency Unit yuan (CNY) At Appraisal (15 Oct 1993) CNY1.00 $1.00 = = $0.173 CNY5.787 At Project Completion (15 Jun 2002) = = $0.121 CNY8.276 At Operations Evaluation (8 Jun 2004) = = $0.121 CNY8.277

ABBREVIATIONS ADB ADTA CMG COD EA EIRR EPB FIRR LPG MRM NO2 NOx O&M OEM PCO PCR PIA PPAR PPTA PRC RRP SO2 SOE TA TMG TSP WACC Asian Development Bank advisory technical assistance Chengde Municipal Government chemical oxygen demand Executing Agency economic internal rate of return environmental protection bureau financial internal rate of return liquefied petroleum gas Management Review Meeting nitrogen dioxide nitrogen oxides operation and maintenance Operations Evaluation Mission Project Coordination Office project completion report Project Implementation Agency project performance audit report project preparatory technical assistance Peoples Republic of China Report and Recommendation of the President sulfur dioxide state-owned enterprise technical assistance Tangshan Municipal Government total suspended particulate matter weight and average cost of capital

WEIGHTS AND MEASURES km m m2 m3 MJ mm kilometer meter square meter cubic meter mega joule millimeter

NOTE In this report, "$" refers to US dollars.

Director, Operations Evaluation Division 2 Evaluation Team Leader

: :

David Edwards C.C. Yu

Operations Evaluation Department, PE-654

CONTENTS Page BASIC DATA EXECUTIVE SUMMARY I. BACKGROUND A. Rationale B. Formulation C. Purpose and Outputs D. Cost, Financing, and Executing Arrangements at Appraisal E. Completion and Self-Evaluation F. Operations Evaluation PLANNING AND IMPLEMENTATION PERFORMANCE A. Formulation and Design B. Achievement of Outputs C. Cost and Scheduling D. Procurement and Construction E. Organization and Management ACHIEVEMENT OF PROJECT PURPOSE A. Operational Performance B. Performance of the Operating Entities C. Financial and Economic Reevaluation D. Sustainability ACHIEVEMENT OF OTHER DEVELOPMENT IMPACTS A. Socioeconomic Impact B. Environment and Health Impacts C. Impacts on Institutions and Policy OVERALL ASSESSMENT A. Relevance B. Efficacy C. Efficiency D. Sustainability E. Institutional Development and Other Impacts F. Overall Rating G. Assessment of Asian Development Bank and Executing Agency Performance iii v 1 1 1 1 3 3 3 4 4 6 7 7 8 9 9 11 12 13 14 14 14 15 16 17 17 18 18 18 19 19

II.

III.

IV.

V.

C.C. Yu, senior evaluation specialist (team leader), was responsible for the preparation of this report; conducted document reviews and key informant interviews; and guided the fieldwork undertaken by Naiyi Hu, Dongming Li, and Zhaohui Hu (staff consultants). In accordance with the guidelines formally adopted by the Operations Evaluation Department (OED) on avoiding conflict of interest in its independent evaluations, the Director General of OED did not review this report and delegated approval of this evaluation to the Director of Operations Evaluation Division 2. To the knowledge of the management of OED, there were no conflicts of interest of the persons preparing, reviewing, or approving this report.

ii VI. ISSUES, LESSONS, AND FOLLOW-UP ACTIONS A. Key Issues for the Future B. Lessons Identified C. Follow-Up Actions and Recommendations 20 20 21 22

APPENDIXES 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. Subproject 1: Gas Supply and Distribution Network System Subproject 2: District Heating System Subproject 3: Coal Gasification Plants Under the New Gas Company Subproject 4: Pollution Abatement at Tangshan No. 2 Porcelain Factory Subproject 5: Pollution Abatement at Tangshan No. 6 Ceramics Factory Subproject 6: Tangshan Dongjiao Wastewater Treatment Plant Subproject 7: Coal Gasification Plant Under the New Gas Company Project Costs Assumptions for Financial Analysis Assumptions for Economic Analysis Environmental Indicators for Tangshan 23 28 33 35 40 45 51 56 59 68 78

Attachment:

Management Response on the Project Performance Audit Report on Tangshan and Chengde Environmental Improvement Project in the Peoples Republic of China and Operations Evaluation Department Comment on Management Response

BASIC DATA Tangshan and Chengde Environmental Improvement Project (Loan 1270-PRC)
Project Preparation/Institution Building TA Technical Assistance Name No. 1831 Tangshan and Chengde Environmental Improvement Project 1916 Institutional Strengthening of the Environmental Protection Bureaus of Tangshan and Chengde Municipalities Key Project Data ($ million) As per ADB Loan Documents 237.0 140.0 140.0 Actual 291.86 124.93 124.93 15.07 Actual 930 May 1993 17 Aug2 Sep 1993 2527 Oct 1993 25 Nov 1993 22 Mar 1994 9 Jun 1994 6 Dec 1994 Jan 2000 29 Sep 2000 66 PCR PPAR Type PPTA ADTA PersonMonths 4.0 22.5 Amount ($000) 100.0 450.0 Approval Date 31 Dec 1992 28 Jul 1993

Total Project Cost Foreign Exchange Cost ADB Loan Amount/Utilization ADB Loan Amount/Cancellation Key Dates Fact-Finding Appraisal Loan Negotiations Board Approval Loan Agreement Loan Effectiveness First Disbursement Project Completion Loan Closing Months (effectiveness to completion) ECONOMIC AND FINANCIAL INTERNAL RATES OF RETURN (%) Economic Internal Rate of Return Subproject 1 2 3 and 5 4 6 7 Project Financial Internal Rate of Return 1 2 3 and 5 4 6 7 Project

Expected IIII Aug 1993 III Oct 1993 23 Nov 1993 22 Jun 1994 May 1999 30 Jun 1999 60 Appraisal

18.6 12.3 16.11 14.6 14.0 -

14.4 14.1 5.0 10.7 14.1 10.1 11.9

16.8 13.4 4.2 -4.2 13.5 17.6 14.7

12.1 10.8 13.8 8.3 11.8 10.7 11.1

9.8 5.9 3 4.2 7 7.6 7.1

11.5 6.2 -2.4 -8.5 3.6 11.7 8.5

Estimated for Subproject 5 only, not Subproject 3.

iv

Borrower Executing Agencies

Peoples Republic of China Tangshan Municipal Government Chengde Municipal Government

Mission Data Type of Mission Fact-Finding Appraisal Project Administration Review Project Completion Operations Evaluation

No. of Missions 1 1 7 1 1

Person-Days 231 96 59 39 76

EXECUTIVE SUMMARY Rapid industrialization and years of neglect of environmental protection resulted in severe environmental degradation and pollution in the Peoples Republic of China (PRC), particularly during the 1980s and 1990s. In the urban areas, heavy use of coal for both industrial production and heating/cooking, often based on obsolete and inefficient combustion technologies, caused excessive air emissions. Government policies for addressing environmental problems and for ensuring sustained, stable, and coordinated economic development were contained in the Eighth Five-Year Plan (19911995), which, inter alia, addressed the need to develop comprehensive environmental management at the municipal level. The operational strategy of the Asian Development Bank (ADB) in the PRC in the early 1990s aimed to achieve three objectives: improving economic efficiency, reducing poverty, and improving the environment and conserving natural resources. The Tangshan and Chengde Environmental Improvement Project (the Project) was an integral part of the national plan for urban environmental improvement and a part of the longterm strategy for addressing the serious air and water pollution in these municipalities in Hebei Province. The main purpose of the Project was to reduce air and water pollution in the two municipalities, which had reached severe levels. The Project also aimed to introduce the most advanced and environmentally friendly technologies to maximize the beneficial impact on environment, which would have beneficial externalities in terms of energy and industrial efficiency, and product quality. It was to consist of two parts. Part A, for Tangshan Municipality, was to comprise six subprojects: five to supply coal gas and district heating, and to convert old, inefficient, coal-fired industrial kilns to modern, efficient, gas-fired kilns; and one to build a wastewater treatment plant. Part B, for Chengde Municipality, was to comprise one subproject to build a coal gasification plant to supply the city with coal gas. In addition, an advisory technical assistance (TA) grant was approved, prior to loan approval, to strengthen the capabilities of the Tangshan and Chengde environmental protection bureaus (EPBs), including improving their organizational arrangements, establishing a comprehensive computer-based management information system, developing of environmental planning guidelines, and addressing short-term and long-term training and human resources needs. A loan of $140.0 million, approved by ADB in November 1993, became effective in June 1994. The total project cost was estimated at $237.0 million equivalent, including $140.0 million in foreign exchange cost and $97.0 million equivalent in local currency cost. The foreign exchange cost was to be financed by ADB, while the local currency cost was to be financed by the Executing Agencies own resources and by domestic banks. The Operations Evaluation Mission (OEM) visited Beijing, Tangshan, and Chengde in June 2004. It found that, while project components were mostly implemented as envisaged at appraisal, the quality of implementation varied, ranging from highly satisfactory or excellent to dysfunctional. Despite the complexities of the Project and changes in scope, the loan was closed in September 2000 after one extension, 15 months behind schedule. The actual project cost at completion was $291.86 million equivalent, comprising $124.93 million in foreign exchange cost and $166.93 million equivalent in local currency cost, resulting in a $54.86 million cost overrun, or 23% more than the appraisal estimate. ADB loan utilization amounted to $124.93 million to cover the foreign exchange cost; the remaining $15.07 million was cancelled. Since its commercial commissioning in October 1999, Subproject 1 (Gas Supply and Distribution) has increased the gas supply capacity of the Project Implementation Agency (PIA) by 85%, from 365,000 cubic meters per day (m3/day) in 1993 to the present 670,000 m3/day. The number of households served grew from 149,000 to 271,000 during the same period,

vi presently covering 96.5% of the households in the city and exceeding the target of 90%. Subproject 2 (District Heating) had a slow start in reaching its design capacity due to delays in construction of the original heat source, the Xijiao Cogeneration Plant. However, the PIA secured alternative heat sources, which have enabled the distribution network to reach 91% of its design capacity. The coal gasification plant built under Subproject 3 on the premises of Tangshan No. 6 Ceramic Factory was operated safely for 5 years between 1996 and 2001 before being shut down. In 2002, the factory was connected to the city gas supply due to its increased capacity, cheaper costs, and safety concerns. Subprojects 4 and 5 (both Pollution Abatement) encountered major problems with some of the equipment imported. In the case of Subproject 4, the kiln, the main piece of equipment financed by the ADB loan, was never fully commercially commissioned after several failed trial runs. The PIA spent its own resources (after ADB loan closing) to convert its old, inefficient, coal-fired kilns to gas firing. In the case of Subproject 5, the kilns were performing well, but the molding and spraying equipment were never functional. The PIA was forced to spend additional resources to procure domestically produced substitute equipment, which is less efficient and more labor intensive. Under Subproject 6, two identical wastewater treatment plants were built in Tangshan instead of one as envisaged at appraisal, with a combined capacity of 300,000 m3/day. They have been operating well. Together with two existing smaller plants, they brought the municipal wastewater treatment ratio to about 65%, making Tangshan one of the top cities in the PRC in terms of wastewater treatment. Since its commissioning in September 1999, the gasification plant built in Chengde under Subproject 7 has reached or exceeded its design capacity for producing its key products, viz., coke and coal gas. The production of coke has brought significant economic benefits to the Chengde Iron and Steel Company, the PIA, by ensuring a stable supply of high-quality and low-cost coke. However, the coal gas produced, which was to be transmitted through a 40-kilometer (km) gas distribution network linking the gasification plant to the city, located 20 km away, was consumed mostly on site by the PIA. The demand for gas by Chengde city has not materialized as envisaged at appraisal. The gas supply system, which was designed to serve at least 50,000 households in Chengde in order to break even financially, currently serves only 12,000 households. To a varying degree, all seven subprojects achieved their main stated objective of improving air and water quality in the two cities. The appraisal targets of pollution reduction have been mostly achieved with the exception of Subproject 2 and Subproject 7. In the case of Subproject 2, about half of the appraisal targets of air emission reduction had been achieved as of 2003, even though the subproject achieved the highest overall air pollution reduction among all the subprojects. In the case of Subproject 7, although the emission reduction targets were not estimated and were probably achieved numerically, because of the fact that most of the gas produced was consumed near the steel plant, the air quality of Chengde city has not benefited directly in a significant manner. The air and water quality in Tangshan has improved significantly since the early 1990s. On air quality, all three main pollutants, viz., total suspended particulates (TSP), sulfur dioxide, and nitrogen dioxide, experienced a decline from 1990 to 2003, ranging from 13% to 82%. The Project, with subprojects on coal gas supply, district heating, and kiln conversion from coal to gas, contributed significantly to pollution reduction, particularly that from TSP. Tangshans water quality also experienced significant improvement during the same period, although less dramatic compared with air quality. The quality of the Dou River, the main river that runs through Tangshan and benefits from the Project, met Class II standards, with two of its six sections being monitored in 2003. The OEM was informed that the air quality in Chengde has also improved in recent years.

vii

The Project was relevant to achieving the strategic goal of the Government on sustainable development and ADBs operational strategy to improve economic efficiency and the environment. However, the relevance of Subprojects 3, 4, and 5 has lessened somewhat, as ADB no longer provides assistance to state-owned enterprises (SOEs) directly for energy efficiency and technological improvement. Overall, the Project was relevant. The subprojects have mostly achieved their environmental objectives, but the economic benefits for some subprojects did not materialize; partly as a result, the concerned PIAs are in a very difficult financial situation. Overall, the Project was partly efficacious. The execution of different subprojects was generally on schedule, with some exceptions due to changes in scope. The overall recalculated economic internal rate of return is about 14.7%, but there are significant variations across subprojects, ranging from negative to 17%. Overall, the Project was partly efficient. With the exception of Subprojects 3, 4, and 5, the remaining subprojects are likely to be sustainable in view of the strong capabilities of the PIAs to operate and maintain the facilities, satisfactory financial performance of the operating entities and the subprojects, and/or strong government policy and financial support. The Project has had a significant impact on environmental improvements, particularly in Tangshan and, to a lesser degree, in Chengde. Through the related advisory TA and other activities, the Project made a significant contribution to improving the institutional capacities of the Tangshan and Chengde EPBs. Overall, the Project is rated partly successful, bordering successful, with the following ratings given to individual subprojects: Subproject 1, highly successful; Subprojects 2, 5, and 6, successful; Subproject 3, partly successful bordering unsuccessful; and Subprojects 4 and 5, unsuccessful. The TA is rated successful. Two main issues that continue to have relevance to ADBs current operations in the PRC are identifiable. First, the experience of the Project appears to lend support to ADBs current operational strategy in the PRC, i.e., more focus on noncommercial sectors through public utilities to achieve public goods including water supply and wastewater treatment, gas supply, and district heating, and staying away from direct support to SOEs in essentially industrial projects. Second, environmental improvement has become a mainstay of ADBs operations in the PRC. Compared with single-investment projects, integrated environmental improvement projects for a city have several advantages including greater impact-staff input ratio. They also have substantial risks, including mixing bad with good, and difficulties in loan appraisal and implementation due to the more diverse scope. On balance, however, the benefits can outweigh the risks. The challenge for ADB is to improve its capability to bridge the sector gap within the organization in order to bring about greater impact with fewer resources. Three key lessons have been identified: (i) selecting suitable, not untested, technologies, and the need to address the technological risks explicitly and thoroughly; (ii) for a developing country like the PRC, achieving economic benefits is a prerequisite for sustainable environmental improvement, and ADB should not try to de-emphasize the importance of achieving economic benefits in environmental improvement projects; and (iii) developmental impact is not achieved at loan approval and, despite generally sound implementation, given the strong performance by both the Executing Agencies and ADB, ADB could have done more to improve the implementation for some subprojects. Under the Loan Agreement, the Government is committed not to provide any subsidy or budgetary grant to any PIA after 1993 and to ensure that utility enterprises set prices that allow full recovery of operating and capital costs and provide an adequate return on investment. These were not fully complied with and should be complied with in a predetermined phased manner. Since decisions on subsidies and prices are often made at a higher level than PIAs and even municipal governments, ADB needs to build on its strong past and ongoing efforts to assist the Government in the areas of tariff reforms for water supply and wastewater treatment and to

viii continue its dialogue with the Government on water and gas tariff reforms. The reforms are also important to ensure the financial viability of ADBs ongoing and future environmental improvement projects.

David Edwards Director Operations Evaluation Department Evaluation Division 2

I. A. Rationale

BACKGROUND

1. Rapid industrialization and years of neglect of environmental protection resulted in severe environmental degradation and pollution in the Peoples Republic of China (PRC), particularly during the 1980s and 1990s. In the urban areas, heavy use of coal for both industrial production and heating/cooking, often based on obsolete and inefficient combustion technologies, caused excessive air emissions and wastewater. Air pollution in PRC cities, particularly in the north during the winter, was among the most severe in the world. 2. Environmental protection became a national priority in the PRCs development strategy in the early 1990s. Government policies for addressing environmental problems and for ensuring sustained, stable, and coordinated economic development were outlined in the Eighth Five-Year Plan (19911995), which emphasized strict compliance with environmental protection, laws and regulations. The plan also aimed to develop comprehensive environmental management at the municipal level, to disseminate information on environmental protection, and to encourage development of environmental protection technologies. The operational strategy of the Asian Development Bank (ADB) in the PRC in the early 1990s aimed to achieve three objectives: improving economic efficiency, reducing poverty, and improving the environment and conserving natural resources. B. Formulation

3. During the February 1992 PRC Country Program Mission, the Government requested ADB to support the implementation of measures to improve air and water quality in Tangshan and Chengde municipalities, both in Hebei Province in the northern PRC. The Tangshan and Chengde Environmental Improvement Project (the Project) was to be an integral part of the national plan for urban environmental improvement and a part of the long-term strategy for addressing the serious air and water pollution in these municipalities. In support of its request, the Central Government, the Tangshan Municipal Government (TMG), and the Chengde Municipal Government (CMG) submitted to ADB detailed feasibility and environmental impact assessment reports for the Project. In December 1992, ADB approved technical assistance (TA)1 to review the feasibility reports and to ascertain the technical, financial, and economic feasibility of the Project. Based on the consultants confirmation of the Projects feasibility, and a series of ADB missions, ADB approved the loan in 1993.2 The Project comprised seven subprojects on coal gas supply, district heating, energy efficiency improvement in porcelain and ceramic factories, wastewater treatment, and coal gasification. Many of the subprojects clearly had dual purposes in that they aimed at achieving both economic benefits in the form of energy efficiency and environmental benefits in terms of emission reduction. All of them targeted stateowned enterprises (SOEs) through investing in newer and cleaner production technologies or environmental improvement facilities. C. Purpose and Outputs

4. The main purpose of the Project, as stated in the Report and Recommendation of the President (RRP), was to reduce air and water pollution in Tangshan and Chengde municipalities
1

TA 1831-PRC: Tangshan and Chengde Environmental Improvement Project, for $100,000, approved on 31 December 1992. Loan 1270-PRC: Tangshan and Chengde Environmental Improvement Project, for $140 million, approved on 25 November 1993.

2 which had reached severe levels. Since the Project was to introduce the most advanced and environmentally friendly technologies to maximize the beneficial impact on environment, it would also have beneficial externalities in terms of industrial efficiency and product quality. 5. Part A of the Project, for Tangshan Municipality, comprised six subprojects (five designed to improve air quality and one to improve water quality ), and Part B, for Chengde Municipality, comprised one subproject designed to improve air quality . Table 1 provides the brief scope at appraisal for each subproject. The detailed scope and evaluation findings for each subproject are presented in Appendixes 17. While no specific purposes were assigned to individual subprojects, based on the scope it may be inferred that all except one targeted air quality improvement and/or production efficiency and quality improvement, while Subproject 6 targeted water quality improvement. Table 1: Summary of Subprojects
Location Tangshan Municipality Subproject Subproject 1: Gas Supply and Distribution Network System Subproject 2: District Heating System Subproject 3: Coal Gasification Plants under the New Gas Company Brief Scope at Appraisal Facilities needed to supply incremental town gas so as to bring the total gas supply in Tangshan to about 670,000 cubic meters per day (m3/day) 2 Space heating for about 8.5 million (m ) consisting of 4.93 million 2 2 m of residential space and about 3.57 million m of space in commercial establishments and public buildings Two coal gasification plants, one on the premises of Tangshan No. 2 Porcelain Factory and the other at No. 6 Ceramic Factory, to be established and operated by the Tangshan Ceramic Industrial Coal Gas Company, Ltd. (a new gas company) to supply gas to the ceramic kilns at these two factories All 5 coal-fired kilns to be demolished and 7 new gas-fired kilns to be established; all 6 heavy, oil-fired roller-kilns to be converted to gas; 2 new gas-fired roller kilns to be established, one financed under the subproject and the other financed from the factorys own resources All 3 coal-fired tunnel kilns to be replaced by two 100-meter gasfired tunnel kilns; upon completion of the 2 new kilns, demolition of all 5 dome kilns and replacement with a new gas-fired tunnel kiln financed from its own resources Dongjiao Wastewater Treatment Plant to be established in the central district of Tangshan Municipality with a population of 343,000 Coal gasification plant, to supply gas to domestic households and commercial and industrial customers, with a design capacity 3 of 720,000 m /day, located 20 kilometers from the city center in Luanhe Township and operated by the Chengde Coal Gasification Company, Ltd.

Subproject 4: Pollution Abatement at Tangshan No. 2 Porcelain Factory

Subproject 5: Pollution Abatement at Tangshan No. 6 Ceramics Factory Subproject 6: Tangshan Dongjiao Wastewater Treatment Plant Subproject 7: Coal Gasification Plant under the New Gas Company

Chengde Municipality

6. In addition to the project preparatory TA (footnote 1), an advisory TA grant3 was approved prior to loan approval. The TA aimed to strengthen the capabilities of the Tangshan and Chengde environmental protection bureaus (EPBs), including organizational improvements, establishment of a comprehensive computer-based management information system, and development of environmental planning guidelines, plus addressing short-term and long-term training and human resources needs.

TA 1916-PRC: Institutional Strengthening of the Environmental Protection Bureaus of Tangshan and Chengde Municipalities, for $450,000, approved on 28 July 1993.

3 D. Cost, Financing, and Executing Arrangements at Appraisal

7. Appendix 8 provides a cost breakdown by project component. At appraisal, the project cost was estimated at $237.0 million equivalent, including $140.0 million in foreign exchange cost and $97.0 million equivalent in local currency cost. ADB was to finance the entire foreign exchange cost.4 The local currency cost was to be financed by the Executing Agencies (EAs) own sources ($42.8 million equivalent) and from domestic commercial loans ($54.2 million equivalent). 8. At appraisal, it was envisaged that TMG would be the EA for Part A, and CMG the EA for part B. Each subproject enterprise would be the Project Implementation Agency (PIA) for its respective component. E. Completion and Self-Evaluation

9. The project completion report (PCR), circulated in October 2002, reported that the Project was implemented mostly as envisaged at appraisal, with moderate delays of 6 months. The seven subprojects, however, experienced different levels of success in terms of completion and operation. 10. With respect to the achievement of the Projects main objective, the PCR provided ambient air quality indicators for key pollutants for both cities since 1993. They indicated for Tangshan a significant improvement of air quality, with sulfur dioxide (SO2) reduced by more than 60%, total suspended particulate (TSP) by 30%, and nitrogen oxides (NOx) by 30%. Significant improvement, particularly in terms of TSP, was also observed for Chengde. 11. The financial internal rate of return (FIRR) and economic internal rate of return (EIRR) were recalculated for the individual subprojects as well as for the Project as a whole. The FIRR and EIRR for the overall Project were above 7.1% and 11.9%, respectively (the appraisal did not estimate the FIRR and EIRR for the Project as a whole). The recalculated FIRRs and EIRRs for the subprojects are 30-70% lower than the corresponding appraisal estimates except in the case of EIRR for Subproject 2. TA 1916 (footnote 3) was considered successful by both the TA completion report (carried out separately) and the PCR, although neither provides adequate information on the TAs achievement of purposes and impact. The PCR concludes that the Project achieved its main objective of air quality improvement despite the population increase of the city. Overall the Project is rated successful in the PCR. F. Operations Evaluation

12. This project performance audit report (PPAR) assesses various aspects of project formulation, design, implementation, and sustainability, as well as the Projects socioeconomic, environmental, and institutional impacts. The assessment is based on a review of ADB documents, discussions with ADB staff, and findings of the Operations Evaluation Mission (OEM), which visited Beijing, and Tangshan and Chengde municipalities during 119 June 2004. The OEM held discussions with the EAsthe Tangshan and Chengde municipal governments; six PIAs; and the Ministry of Finance. The OEM inspected the project facilities and their operation and maintenance (O&M), and held discussions with selected customers. Copies of the draft PPAR

ADBs loan terms to the Government included the pool-based variable lending rate for US dollars with a maturity of 25 years and a grace period of 5 years. The terms of relending (to the Executing Agencies) and onlending (to the Project Implementing Agencies) were the same, i.e., no additional charges.

4 were sent to the Government and concerned ADB departments for review; all comments received have been considered in finalizing the PPAR. II. A. PLANNING AND IMPLEMENTATION PERFORMANCE

Formulation and Design

13. In the early 1990s, Tangshan and Chengde relied on coal to meet about 90% of their energy demands. Industrial SOEs used much of the energy while employing outdated combustion technologies that lacked pollution control measures. The formulation of the Project was in line with ADBs operational strategy for the country at the time, which included improving economic efficiency and the environment. In this context, the Project was viewed by some ADB Board members as hitting two birds with one stone by trying to address both economic efficiency and environmental improvement at the same time. 14. Several policy-oriented and project design-related issues emerged during loan formulation and processing. First, ADB Management encouraged the Appraisal Mission to discuss with the Government in ongoing policy dialogue the introduction of the polluter pays principle and the possibility of accepting a time-bound loan covenant with respect to the introduction of a polluter pays levy for the major polluting industries. Second, some participants at the Management Review Meeting (MRM) felt that too much emphasis might have been given to industrial efficiency improvement and considered that the design of the Project should be more balanced so that it would have dual merits. As will be discussed further (para. 61), the de-emphasis on industrial efficiency improvement as required by Management led to a heavy emphasis, perhaps overly so, on the Projects environmental benefits by the Appraisal Mission, creating a strong gap between the objectives and scope of the Project as outlined in the ADB documents and those as understood by the PIAs. The differences in the perceived nature of the Project had implications for the design process and for the eventual outcome of the Project. Other points raised at MRM included the need for tariff increases and enterprise restructuring; relationship of the Project with other and previous environmental projects by the World Bank and ADB; and the need to address other more polluting sectors rather than just the ceramic industry. In particular, questions were raised at the Board meeting as to whether ADB should focus on areas that would help create a climate in which tapping of capital markets directly by enterprises was possible. Such areas included price reform, cost recovery, enterprise autonomy and financial accountability, and private financing and participation in enterprise management and ownership.5 15. To partly address these broader policy-oriented and specific design-related issues, a small-scale project preparatory TA (footnote 1) was provided to finance the services of four international consultants, viz., an environmental economist, an expert on coal gasification technology, a specialist on the ceramic industry, and a wastewater treatment specialist. Their task was assess the national environment policy framework as well as the policies of Tangshan and Chengde with a view to identifying the major problems and issues affecting the

This question continues to have relevance to the current lending program in the PRC, particularly for environmental improvement, since many end users of past and ongoing loans are SOEs, and the issues of price reforms and enterprise autonomy are still very much unresolved despite progress in some areas. However, it should also be recognized that these are macro-issues and cannot be resolved at the project level. ADB has been in continuous dialogue with and providing assistance to the Government in many of these areas. Furthermore, since the mid1990s, ADB has increasingly reduced its portfolio in the area of industrial pollution abatement and energy conservation by SOEs, and placed more focus on providing assistance to address environmental problems through public utilities, e.g., gas distribution, water supply, and wastewater treatment.

5 implementation of pollution control measures, and to evaluate the technical details and viability of the Project with an aim to preparing it for ADB financing. 16. The OEM reviewed two available consultants reports, one prepared by the environmental economists team6 and the other by the ceramic specialist. 7 The OEM could neither find nor confirm the existence of reports done by the coal gasification and wastewater specialists. A major portion of the environmental economists report was devoted to explaining the PRCs environmental policy and institutional framework at the national level, which was more for the benefit of ADB than the Tangshan and Chengde municipal governments as the EAs of the TA. The OEMs field visit confirmed this assessment, as the EAs had no recollection of the TA. The second portion of the environmental economists report aimed to assess the relevance and cost effectiveness of the nine proposed subprojects at that time.8 17. The environmental economists report provided several reasons for ADB assisting in energy efficiency and environmental improvement, including acceleration of price and enterprise reforms and ADBs unique ability to act as an outside coordinator across different levels of government so that special interests might be moderated. The consultants conducted a simple cost-effectiveness assessment for four subprojects with respect to air emissions and concluded that the district heating subproject (Subproject 2) would achieve the highest cost effectiveness in terms of the amount of pollutants removed per million dollars invested, while the proposed three ceramic industry subprojects would achieve similar but lower (about half) cost effectiveness. The OEM findings partly confirm this assessment. 18. The environmental economists report assessed the financial and cost-recovery policies for urban services in the two borrowing municipalities. It noted that prices for local government services fixed by municipal price bureaus were generally too low to allow full cost recovery even though increasing understanding was evident that full cost recovery prices must be charged for water, gas, electricity, and heat (steam). The report noted that the two municipalities had provided ADB with assurances that all services would be subject to full cost pricing including connection fees and depreciation. 19. The report of the ceramic industry specialist assessed the technical viability of the proposed subprojects for three ceramic enterprises. In the end, only the second and third enterprises, i.e., Tangshan No. 6 Ceramic Factory and Tangshan No. 2 Porcelain Factory, were chosen, while the first one, Tangshan Victory Ceramic (Group) Corporation, which consisted of four factories, was dropped from project financing. In general, the consultants provided a positive assessment of the proposed improvements for both factories. Specifically, Tangshan No. 2 Porcelain Factory was viewed as the most advanced and well-managed factory of all, and the proposed technical enhancements (under Subproject 4) and machines/equipment envisaged were believed to be justifiable and technically sound. For Tangshan No. 6 Ceramic Factory, the proposed subproject (Subproject 5) was found to be logical and conformed to the latest international technical standards. However, as will be seen (para. 21), both subprojects experienced technical problems, and the problems with Subproject 4 may have been particularly due to design and procurement of the equipment.
6

Harvard Institute for International Development, March 1993, Improving the Environment in the Peoples Republic of China: Tangshan and Chengde Environmental Improvement Project, for Asian Development Bank, Contract No. CPCS/93-069. GERI Engineering GmbH, July 1993, Ceramic Industry Technical Evaluation and Assessment of Project Viability: Tangshan Environmental Improvement Project, for Asian Development Bank. Subproject 1, Gas Supply and Distribution Network System, was not among the original nine subprojects, which included an additional wastewater treatment plant, a ceramic factory, and an iron-making factory.

B.

Achievement of Outputs

20. The details of the outputs from each subproject are presented in Appendixes 17. In general, the subprojects were implemented largely as envisaged, with only minor delays and modifications in most cases. The quality of the equipment and installation was generally satisfactory, and excellent in some cases. Several exceptions and modifications should be mentioned. For example, under Subproject 2, 12 sets of radio signal transmission equipment and 1 set of computer-based control equipment were procured instead of 85 sets and 2 sets, respectively, as envisaged by the original design and strongly advocated by the international consultants. The purpose was to save costs by continuing to make use of the existing control equipment. Under Subproject 3, the planned gasification plant for Tangshan No. 2 Porcelain Factory was cancelled, as the factory was able to secure its gas supply from Tangshan Gas Company, but the other gasification plant was constructed, as envisaged, on the premises of Tangshan No. 6 Ceramic Factory. Under Subproject 6, the Dongjiao Wastewater Treatment Plant was implemented as envisaged and was commissioned in October 1997. Due to competition and other factors, there was a significant loan saving. With ADBs approval, a second plant of identical design, the Beijiao Wastewater Treatment Plant, was constructed and commissioned in November 2001. The only subproject in Chengde, Subproject 7, was implemented largely as envisaged at appraisal, with only minor delays. The quality of the construction was satisfactory to excellent. The plant manager proudly informed the OEM that the plant is one of the best in the PRC with similar capacities. 21. Major problems were encountered with Subprojects 4 and 5. Under Subproject 4, the original intention of the PIA was to use the ADB loan to procure a new gas-fired roller kiln to produce high-quality porcelainware. The PIA would then use the money generated from the new products to finance the conversion of its old coal-fired and oil-fired kilns to gas firing. However, the new gas-fired roller kiln established using ADB loan proceeds was never commercially commissioned due to various problems related to poor design, adoption of untested technology, and the contractors poor performance. Its products were of unstable quality in terms of size and color, and could not meet the quality standards of the intended export markets. The equipment has been idle since 2002. As a result, the PIA had to spend its own resources, after ADB loan closing, to convert its old, inefficient, coal-fired kilns to gas firing. Under Subproject 5, the subproject was constructed largely as envisaged, including two highly automated tunnel kilns, one shuttle-type kiln, one gas-fired dryer, one set of electrostatic spraying equipment, and 16 pieces of high-pressure and 1 piece of mid-pressure molding equipment. However, the molding equipment (from a German supplier) was never properly assembled. Due to its sudden bankruptcy, the supplier never dispatched any technicians to assemble the equipment and to conduct the training required.9 The PIA approached the former employees of the supplier in an effort to bring them to the site to help with the installation, but the price they demanded was too high. In the end, all other efforts also failed, and the equipment, at a cost of $6 million, was never made functional. In addition, the spraying equipment, at a cost of about $500,000, could not reach the performance standards and was not functional at the time of the OEM. As a result, the PIA had to invest additional resources to procure domestically produced molding and spraying equipment, which is less automated and efficient, and more labor intensive.

According to the PIA and EA officials interviewed, the molding equipment was procured in advance in an effort by the PIA to avoid paying import tax, which was to be introduced by the Government the following year.

7 C. Cost and Scheduling

22. The OEM tried to confirm the costs and scheduling for each subproject with the respective PIAs. The detailed accounts of the subproject costs contained in Appendixes 17 point out the differences between the PCR cost estimates and the cost figures provided to the OEM by the PIAs, even though in many cases the differences are minor or moderate. However, the OEM is generally of the view that the PCR estimates are correct on the ground that (i) at least for the foreign exchange costs funded by ADB, the PCR estimates added up to the total ADB disbursement (i.e., $124.93 million); and (ii) later estimates of costs could be subject to more errors and inconsistencies resulting from, for example, different exchange rates or changes in accounting practices and personnel. 23. The total actual project cost at completion was $291.86 million equivalent, comprising $124.93 million in foreign exchange cost and $166.93 million equivalent in local currency cost, resulting in a $54.86 million cost overrun, or 23% more than the appraisal estimate (Appendix 8). The higher total cost was caused mostly by the higher local currency costs in Subproject 6, for which there was a doubling of the capacities built (Appendix 6), and in Subproject 7, for which there was an added component of waste gas recovery and longer pipelines connecting the plant to Chengde city (Appendix 7). The ADB loan amounted to $124.93 million to cover the foreign exchange cost, and the remaining $15.07 million was cancelled. 24. Detailed information on implementation scheduling for each subproject is presented in Appendixes 17. For the Project as a whole, despite the complexities and changes in scope, the loan was closed in September 2000 after one extension, 15 months behind schedule. D. Procurement and Construction

25. The PIAs indicated that the procurement of ADB-financed components was carried out in accordance with ADBs Guidelines for Procurement, mostly using international competitive bidding and international shopping procedures, with assistance from the PRC International Technical Tendering Company. The Project also provided loan proceeds for engaging international consultants for design review.10 The international consultants for these services and under TA 1831-PRC (footnote 1) and TA 1916-PRC (footnote 3) were engaged in accordance with ADBs Guidelines on the Use of Consultants. 26. While the EA officials and PIAs were generally satisfied with the tendering companys performance, they pointed out the Governments approval procedures for procuring foreign goods were extremely complex in the early and mid-1990s. The EAs and PIAs had to make visits to Beijing, which is about 300 kilometers (km) away, on a very frequent (sometimes weekly) basis. Although generally the quality of the goods procured was good, some subprojects experienced problems. For example, the PIA for Subproject 1 compared the prices of pipelines procured using its own money and those using ADB loan proceeds, and concluded that the ADB-financed pipelines were about 20% more expensive. The reason given was that only very large suppliers were eligible, since it was a large package. However, the winning vendor procured the pipeline from a local smaller company that had been supplying pipelines to the PIA.11 For some equipment, spare parts are very expensive, in part because the vendors do not sell separate parts but only the assembled ones. Major problems were encountered in Subprojects 4 and 5 with the
10

The Canadian consultants engaged to review the design of the ceramic/porcelain subprojects did not detect any potential design or implementation problems. 11 The OEM could not independently verify this claim. The price differential, if it indeed existed, could be caused by other factors as well, such as different quality or a different market situation during the different time periods.

8 molding and spraying equipment, and kiln (para. 21). In these cases, the vendor either never came to the site to assemble the equipment due to sudden bankruptcy, or came but failed to assemble and test the equipment to the designed performance level. Depending on the complexities of the subprojects and the PIAs own experience and technical capabilities, some PIAs, e.g., that under Subproject 7, had a large number of relatively small tendering packages (56 in that case), whereas in other cases, e.g., Subprojects 4 and 5, the number of packages was much smaller. A relatively large number of packages is probably conducive to cost control but needs to be based on thorough PIA staff familiarity with the technologies involved. 27. The engineering and civil works were generally done in accordance with international standards or generally accepted practices, and in some cases exceeded them. E. Organization and Management

28. The Project was the first development agency-funded project for Tangshan and Chengde municipalities, and the two municipal governments attached high priority to it. For Part A in Tangshan (Subprojects 16), a Project Coordination Office (PCO) was created, headed by the first vice mayor. The deputy director of the PCO was concurrently the director of the Tangshan EPB, and the PCO was physically located in the EPB building. Both the director and the deputy director provided strong and dedicated leadership in coordinating and supervising the implementation of the subprojects by the PIAs and in coordinating with ADB. For Part B in Chengde (Subproject 7), because there was only one subproject, the municipal government delegated the day-to-day supervision and coordination (with other subprojects) to the PIA for the subproject, Chengde Iron and Steel Group, while maintaining its leadership through a leading group headed by Chengdes first vice mayor and the general manager of the steel company. Table 2 lists the names of the PIAs for all the subprojects. Table 2: Project Implementation Agencies
Subproject 1 2 3 4 5 6 7
a

Project Implementation Agency Tangshan Gas Company Tangshan Heat and Power Company Tangshan No. 6 Ceramic Factorya Tangshan No. 2 Porcelain Factory Tangshan No. 6 Ceramic Factory Tangshan Wastewater Treatment Company Chengde Iron and Steel Group

Originally this subproject was to build two gasification plants on the premises of Tangshan No. 2 Porcelain Factory and Tangshan No. 6 Ceramic Factory, to be operated by a separate, single gas company. However, due to the cancellation of the first one, it was decided that Tangshan No. 6 Ceramic Factory would be the PIA for this subproject.

29. The PIAs reported that their initial intention was to use their own engineering departments to manage and supervise the construction activities. However, ADB procedures required them to engage an independent project management and supervision company to supervise all the subprojects. To meet this requirement, a new company, Fangyuan Engineering Supervision Company, was formed. Some PIA officials indicated that the company comprised mostly former employees of the PIAs, so true independence was questionable. Several PIAs informed the OEM that, despite the engagement of the new supervision company, the work was done mostly by the engineering departments and project management teams of the PIAs.

9 Overall, the model of having a PCO in the Government and separate PIAs to implement individual subprojects appears to have worked well, given the strong commitment and ownership at all levels. III. A. ACHIEVEMENT OF PROJECT PURPOSE

Operational Performance

30. The details of the operational performance of each subproject, in terms of both production and environmental benefits, are presented in Appendixes 17, with highlights summarized below. 1. Improvement in Capacity and Quality of Production/Services

31. Since its commercial commissioning in October 1999, Subproject 1 Tangshan (Gas Supply and Distribution) has increased the gas supply capacity of the PIA by 85% from 365,000 cubic meters per day (m3/day) in 1993 to the present 670,000 m3/day. The number of households served grew from 149,000 to 271,000 during the same period, presently covering 96.5% of households in the city and exceeding the target of 90%. Subproject 2 Tangshan (District Heating) had a slow start in reaching its design capacity due to delays in construction of the original heat source, the Xijiao Cogeneration Plant. However, the PIA secured alternative heat sources, which have enabled the distribution network to reach 91% of its design capacity. With the measures already taken and firm evidence that more measures are being or will be taken, the OEM believes that the heating system will achieve its design capacity of 8.5 million square meters (m2) by 2006. The coal gasification plant built under Subproject 3 on the premises of Tangshan No. 6 Ceramic Factory was operated safely for 5 years between 1996 and 2001 before it was shut down.12 In 2002, the factory was connected to the city gas supply due to its increased capacity, cheaper costs, and safety concerns. 32. Subprojects 4 and 5 encountered major problems with some of the imported equipment (para. 21). As a result, in the case of Subproject 4, the kiln, the main piece of equipment financed by the ADB loan, was never fully commercially commissioned. The PIA had to spend its own resources (after ADB loan closing) to convert its old, inefficient, coal-fired kilns to gas firing. In the case of Subproject 5, the kilns were performing well but the molding and spraying equipment was never functional. The PIA was forced to spend additional resources to procure domestically produced equipment, which is generally less efficient and more labor intensive. 33. The two wastewater treatment plants built in Tangshan under Subproject 6, with a combined capacity of 300,000 m3/day, have been operating well. Together with two existing smaller plants, they brought the municipal wastewater treatment ratio to about 65%, making Tangshan one of the best cities in the PRC in terms of wastewater treatment. Since its commissioning in September 1999, the gasification plant built in Chengde under Subproject 7 has reached or exceeded its design capacity in producing its key products, viz., coke and coal gas. The production of coke has brought significant economic benefits to the Chengde Iron and Steel Company, the PIA, by ensuring a stable supply of high-quality and low-cost coke. However, the coal gas produced, which was to be transmitted through the 40-km gas distribution network linking the gasification plant to the city located 20 km away, was consumed mostly on site by the PIA. The internal consumption of the gas arises because the external
12

The OEM was informed that the PIA is trying to sell the facilities, perhaps to an industrial customer in a far away location without access to the city supply of gas. However, the OEM feels that the chances of finding a buyer that can operate the plant safely are diminishing rapidly as time goes by.

10 demand for gas by Chengde city has not materialized as envisaged at appraisal due to the low price of coal, competition from liquefied petroleum gas, and the required high connection fees (para. 5 of Appendix 7). The gas supply system, which was designed to serve at least 50,000 households in Chengde in order to break even financially, currently serves only 12,000 households. The PIA wishes to sell a major portion of the gas to get higher additional revenue. 2. Environmental Improvement

34. Environmental improvement was stated as the main purpose of the Project. The seven subprojects, to varying degrees, have achieved the objective of improving air and water quality. Table 3 provides a summary of the achievement by the six subprojects with an objective of improving air quality in terms of emission reductions. It indicates that the appraisal targets have been mostly achieved with the exception of Subprojects 2 and 7. In the case of Subproject 2, about half of the appraisal targets had been achieved as of 2003, even though the subproject achieved the highest overall pollution reduction among all the subprojects. As discussed (para. 33), in the case of Subproject 7, although the emission reduction targets were not estimated and probably achieved numerically, as most of the gas produced was consumed near the steel plant, the air quality of Chengde city has not benefited directly in a significant manner. Table 3: Summary of Air Pollution Reduction by Subprojecta
(tons)

Subproject 1 2 3+5 4 7
a

SO2 Reduction Annual Target 4,340 5,750 500 500 4,340

SO2 Reduction (2003) 4,200 2,650 500 500 n.e.

TSP Reduction Annual Target 6,510 96,000 338 338 50,000

TSP Reduction (2003) 6,510 44,200b 338c 338c n.e.

n.e. = not estimated; SO2 = sulfur dioxide TSP = total suspended particulate. These results were derived from comparisons of with- and without-project scenarios rather than absolute reduction. Due to economic growth, total emissions of the two cities may have decreased to a lesser extent or even increased in the case of SO2. b The less-than-half reduction of emissions compared with the appraisal target is caused by the fact that the capacity of the heat source (cogeneration plant) in 2003 was only half of the original design capacity. c In addition to TSP, there has been a large reduction of coal slag, which is not estimated. Source: PIAs and OEM.

35. In terms of water quality improvement, with the doubled wastewater treatment capacity achieved under Subproject 6, the Project has largely achieved its objective. Table 4 contains the wastewater treatment parameters for the Dongjiao Wastewater Treatment Plant since 1999, showing that it runs at 60% of its capacity; the quality of effluents exceeded the national effluent standards (Class II). The Beijiao Wastewater Treatment Plant also has similar performance (Appendix 6).

11
Table 4: Key Operational Performance Indicators of Dongjiao Wastewater Treatment Planta
1999 Influent Effluent COD (mg/L) BOD5 (mg/L) SS (mg/L) pH 849 67.3 874 46.3 8.1 37.7 7.2 National 2000 2001 2004 (up to May) Effluent Influent Effluent Influent Effluent Influent Effluent Standard 335 46.8 536 57.6 11.8 26.7 6.9 300 58.7 569 68.7 9.7 27.6 6.1 386 121 334 6-9 52 10 21 6-9 120 30 30 6-9

= not available, BOD = biological oxygen demand, COD = chemical oxygen demand, mg/L = milligrams per liter, NH3 = ammonia, pH = acidity value, SS = suspended solids. a Capacity: 150,000 m3/day, average flow rate = 90,000 m3/day. Source: Tangshan Wastewater Treatment Company.

B.

Performance of the Operating Entities

36. The details of the performance of the operating entities for each subproject are presented in Appendixes 17, with highlights summarized below. 37. Generally, with the exception of those for Subprojects 4 and (3+5), the PIAs for the other subprojects are performing satisfactorily. Subprojects 1, 2, 6, and 7 have generally improved the PIAs operational and financial performance, and they are capable of servicing at least a portion of the ADB debt. The strongest performers are the Tangshan Gas Company (Subproject 1), which achieved 17% annual growth in sales since 1995; the Tangshan Heat and Power Company (Subproject 2), which achieved 11% annual sales growth since 1995; and the Chengde Coal Gasification Company, which achieved 26% annual sales growth since 2000. These three PIAs are capable of fully servicing their ADB debt and other long-term debts. For the Tangshan Wastewater Treatment Company (Subproject 6), despite the fact that its sales also experienced a 17% annual growth since 1998, it has not broken even financially and has the capability to service only about 25% of its ADB debt. This situation is due to the relatively low wastewater tariff and underutilized capacities (with a 55% utilization rate for the combined capacities of the two new plants) because of the lower-than-expected demand due to industries own initiatives of treating and recycling wastewater. A common problem for all of the PIAs is that, despite the strong growth in sales, profitability has not improved as fast as sales, and there is significant room for cost cutting. For example, the Tangshan Heat and Power Company had a staff of 2,700 people, and the OEM estimated that about 800 people worked to operate and maintain the subproject facilities. This yields a ratio of 9,669 m2 of heating area per staff member, much lower than world levels and even lower than the PRC average.13 38. The PIAs for Subprojects (3+5) and 4, the Tangshan No. 6 Ceramic Factory and the Tangshan No. 2 Porcelain Factory, are currently financially insolvent and have no capability to repay their debt. Although the failure cannot be blamed entirely on the ADB subprojects, as there are other external factors such as fierce market competition, weak commercial decisionmaking structure at the SOEs, and poor management, the nonperformance of some key components of the subproject has undoubtedly had a devastating impact of the performance of
13

The PRC has an average of 10,000-12,000 m2 per staff member, while in the United States or Norway this ratio could be 10 times higher.

12 the two factories. In this regard, the OEM noted that both PIAs had very low net fixed assets relative to ADBs loan amounts at the time of loan formulation. This made them very vulnerable in terms of liabilities and debt-servicing capabilities if the subprojects failed, as has happened in this case.14 Although in the RRP the forecast debt-equity ratio, less than 80:20 for all years, and debt-service ratio, higher than 1 in all years, were both within the covenanted levels, the forecast relied mostly on assumed large amounts of retained earnings, which never materialized or were much less than envisaged. ADBs Updated Guidelines for the Financial Governance and Management of Investment Projects Financed by ADB, approved in 2001, suggests that the debt-equity ratio indicator is normally only used for new enterprises such as greenfield industrial plants, for which application of the debt-service coverage ratio is not practical due to lack of earning records. The Guidelines also suggests that it is generally inappropriate to have a debt-equity ratio higher than 60:40 for most industrial projects. Exceptions can be made for enterprises having very dependable earning power such as public utilities, for which this ratio may be raised to 70:30 or higher. The two ceramic and porcelain factories clearly fell into the former category, i.e., industrial plants subject to market competition and a less dependable earning stream. It may be argued that ADBs 80:20 covenanted level of debt-equity ratio, which may have been appropriate for the other subprojects targeting public utilities, was not stringent enough for Subprojects (3+5) and 4. C. Financial and Economic Reevaluation

39. Appendixes 9 and 10 contain a recalculation of the FIRRs and EIRRs for the subprojects and for the Project as a whole. All financial costs and benefits are denominated in the local currency at 2003 constant prices, while the economic costs and benefits are valued at economic prices at the border using the world price numeraire. As summarized in Table 5, the recalculated FIRRs for the subprojects are lower or substantially lower than those from the RRP, with the exception of Subproject 7 (the FIRR estimate for Subproject 7 was substantially influenced by recent price hikes in and high demand for the main product of the plant, coke). In comparison with PCR estimates, however, subprojects 1 and 2 also show an improvement. The overall recalculated FIRR is 8.5%, lower than the appraisal estimate of 11.1%, but higher than the PCR estimate of 7.1%, and higher than the recalculated weighted average cost of capital (WACC) of 5.4%. Despite the satisfactory overall FIRR, there were substantial variations across subprojects. In particular, Subprojects (3+5) and Subproject 4 had negative FIRRs, and Subproject 6 had a FIRR of 3.6%, lower than the recalculated WACC of 4.3%. The recalculated overall EIRR was 14.7%, or about 20% higher than the 12% cutoff rate. Sensitivity analyses conducted for individual subprojects indicate that the EIRRs can fluctuate 10-20% as costs and prices vary by 10%, which could lead to an overall EIRR lower than the 12% cutoff value. In addition, as in the FIRR, the variations of EIRRs across subprojects are also significant, from negative in the case of Subproject 4 to a high of 16-18% in the cases of Subprojects 1 and 7. The Projects main economic benefits accrued from several sources: (i) benefits from improved product quality; (ii) savings of coal, which otherwise would be consumed; (iii) environmental benefits from treated wastewater measured by consumers willingness-to-pay; and (iv) environmental and health benefits from improved air quality. However, due to reasons related to methodology and lack of site-specific data on the health impacts of air pollution, as
14

In 1995, Tangshan No. 6 Ceramic Factory had net fixed assets of only CNY27.22 million. Yet it acquired a loan of $15.72 million (or CNY130.48 million) from ADB for the 2 subprojects. As a result, its net fixed assets quickly increased to CNY150.45 million in 2000, or 5.5 times in 5 years. The nonperformance of some project components, i.e., the molding and spraying equipment valued at $6.5 million or CNY54 million, and the underutilization of the gasification plant, at a cost of $3.55 million, have had a devastating impact on the PIAs financial performance. Similarly, Tangshan No. 2 Porcelain Factory had net fixed assets of CNY16.3 million in 1995 (prior to the subproject) according to the RRP. Yet, it acquired loans of $8.12 million (or CNY67.4 million) from ADB and $9.86 million equivalent (or CNY81.84 million) from local sources for the subproject.

13 elaborated in Appendix 10, the last category of benefit from improved air quality was not quantified. This is consistent with the RRP but deviates from the PCR methodology. From discussions with various stakeholders, the health benefits of the Project are likely to be highly significant (para. 46). Table 5: Summary of Financial and Economic Reevaluation (%)
Subproject 1 2 3+5 4 6 7 Overall Appraisal FIRR EIRR 12.1 10.8 13.0 8.3 11.8 10.7 11.1 18.6 12.3 16.1a 14.6 n.e. 14.0 n.e. PCR FIRR 9.8 5.9 3.0 4.2 7.0 7.6 7.1 EIRR 14.4 14.1 5.0 10.7 14.1 10.1 11.9 FIRR 11.5 6.2 (2.4) (8.5) 3.6 11.7 8.5 PPAR EIRR 16.8 13.4 4.2 (4.2) 13.5 17.6 14.7

EIRR = economic internal rate of return, FIRR = financial internal rate of return, n.e. = not estimated, PCR = project completion report, PPAR = project performance audit report. a Estimated for Subproject 5 only, not Subproject 3.

D.

Sustainability

40. Proper and efficient maintenance is essential for the subprojects operation and long-term sustainability. Of all the subprojects visited by the OEM, most demonstrated adequate capability for O&M. In particular, the Tangshan Gas Company (Subproject 1), Tangshan Heat and Power (Subproject 2), Tangshan Wastewater Treatment Company (Subproject 6), and Chengde Iron and Steel Group (Subproject 7) have been able to operate their facilities in a smooth manner with minimal interruptions and with regular checks on system leakages and other potential causes of interruption. They are all carrying out a regular staff-training program. The OEM observed that most project facilities are being kept in good to excellent condition, and the PIAs have their maintenance rules in compliance with national and international standards or commonly accepted practices. Assuming that the current maintenance level continues, the OEM believes that the project facilities can continue to operate for another 20 years. However, there are exceptions, typically associated with high-cost imported components. For example, the centrifugal sludge dewater equipment (imported from Germany) under Subproject 6 is very expensive to operate and maintain relative to the current tariff levels of wastewater treatment. 41. A major concern for project sustainability arises from the poor financial performance of some subprojects and their operating entities. In particular, Subprojects (3+5) and 4 have negative FIRRs, and two operating entities, Tangshan No. 6 Ceramic Factory and Tangshan No. 2 Porcelain Factory, are financially insolvent (Appendixes 4 and 5). Sustainability of these subprojects is unlikely unless dramatic changes occur with the market and the management/ownership structure of the SOEs. In addition, Subproject 6 also has a FIRR lower than the cost of capital, which also causes some concerns for its long-term sustainability. As detailed in Appendix 6, the PIA for the subproject, the Tangshan Wastewater Treatment Company, has not achieved financial breakeven. However, due to the Governments strong policy

14 on long-term water tariff increases,15 the citys potential economic growth, and financial support for wastewater treatment, the subproject is likely to be sustainable. IV. A. ACHIEVEMENT OF OTHER DEVELOPMENT IMPACTS

Socioeconomic Impact

42. The socioeconomic impact of the Project was mainly realized through improved quality of life due to improved gas supply, district heating, and air and water quality. As an example, the OEM was informed that anglers (mostly retirees) are once again found along the Dou River (into which the treated effluents are discharged) due to the improved water quality. Real estate prices are also reported to be rising near the Beijiao Wastewater Treatment Plant. B. Environment and Health Impacts

43. Environmental improvement was stated as the primary objective of the Project, and the Project has substantially reduced emissions (para. 34). Partly as a result, Tangshans air quality and water quality have improved significantly over the last 10 years or so.16 Appendix 11 provides the air quality monitoring results for Tangshan city. Table A11.1 shows the annual average ambient concentrations for three monitored air pollutants, viz., TSP, SO2, and nitrogen dioxide (NO2). It indicates that, while all three pollutants experienced a decline from 1990 to 2003, the decreases were modest for SO2 and NO2, about 13% in both cases. The most significant drop occurred with TSP, i.e., 82%. This significant decrease may be largely attributed to the dramatic reduction in the citys direct coal combustion, for household stoves (for both heating and cooking) and industrial furnaces, partly due to the Project. However, Table A11.1 also indicates that, despite the improvement, the TSP and SO2 annual averages in 2003 did still not meet National Class II standards. Furthermore, Table A11.2 presents an example of realtime air quality monitoring conducted by Tangshan EPB using one of its automatic monitoring devices in a downtown location on 8 June 2004 (the day of the OEMs visit). It provides an hourly record of ambient concentrations for particulate matter, SO2, and NOx, and the results, published daily in local newspapers and on the EPB website, indicate a strong hour-by-hour change in the pollutants. Even though the annual averages may not meet Class II standards, according to the EPBs 2003 annual report, the number of days in 2003 for which the overall air quality, measured by a nationally adopted air quality index, met or exceeded the standards was 242, an increase of 44 days over 2002.

15

ADB has provided three TAs in the area of tariff setting for water supply and wastewater treatment services. TA 2773: Water Supply Tariff Study, for $600,000, approved in 1997, and TA 3250: Water Tariff Study II, for $950,000, approved in 1999, helped the Government prepare the National Guidelines on Water Tariffs that will ensure full cost recovery and develop institutional and methodological capacities to implement the Guidelines. TA 3749: National Guidelines for Urban Wastewater Tariffs and Management, for $700,000, approved in 2001, aimed to improve urban wastewater management and enable investment in wastewater infrastructure by developing national guidelines for wastewater tariffs, including tariff calculation methodologies that will allow for full cost recovery, taking into consideration affordability and social constraints. 16 Prior to the approval of the Project, both Tangshan and Chengde municipalities formulated their own environmental improvement action plans covering 1991-2000. The Project formed parts of both plans. The action plans were similar in that they covered 6-7 main areas of improvement including gas supply arrangements, district heating system, dust removal, waste treatment facilities, greenification, and relocation/shutting down of polluting industries for Tangshan and preservation of historical places and noise pollution reduction for Chengde. Based on the OEMs observations and interviews with Tangshan EPB officials, Tangshan appeared to have implemented most (if not all) the measures contained in the plan, and the resulting improvement of environmental quality is evident. The situation for Chengde is less clear.

15 44. Tangshans water quality also experienced significant improvement during the same period, although compared with air quality the level of improvement may have been less dramatic. The quality of the Dou River, the main river that runs through the city and benefits from the Project, met Class II standards for two out of its six sections being monitored in 2003. The other four did not meet the standards despite the fact that the Project has helped Tangshan achieve a 65% wastewater treatment rate. This is partly due to the fact that Tangshan is located in a semiarid area, and the quality of many of its rivers is directly related to their flow. During dry season, water quality is much worse than during wet season. 45. The OEM was informed that the air quality in Chengde has also been improved significantly in recent years. However, the OEM noticed that industrial stacks are visible over the citys horizon, and the emissions from some stacks are surely exceeding the standards. For the reason discussed in para. 33, Subproject 7 did not contribute much to improving Chengde citys air quality. Most of the gas produced is consumed at the steel plant, 20 km from the city. However, the OEM was informed that the air quality near the steel plant has improved markedly. 46. An important aspect of environmental improvement is the indoor air quality of the subproject enterprises, which affects workers health and safety. The OEM was informed that in one case, Tangshan No. 6 Ceramic Factory, the improvement of the air quality around the plant after the conversion of kilns from coal to gas firing was so dramatic that one plant worker reportedly expressed his guilt for working in such an improved environment and still taking the same salary.17 However, the OEM found that the current working environment in the two ceramic and porcelain plants has room for improvement and could have been improved by the Project. In particular, the Project aimed to procure imported molding and spraying equipment for Tangshan No. 6 Ceramic Factory. However, due to the nonperformance of the equipment, the factory had to spend additional resources to buy domestically made equipment, which is semiautomatic or manual. The OEM observed that most workers operating the equipment were not wearing masks, and the indoor air quality in the spraying section was particularly unsuitable for long hours of work.18 C. Impacts on Institutions and Policy

47. The policy and institutional impacts of the Project were mainly achieved through the related advisory TA (footnote 3). TA 1916 had a stated purpose to strengthen the capabilities of the Tangshan and Chengde EPBs (para. 6). 48. The TA consultants reviewed the current organizational structure of the EPBs and developed recommendations for improving their structure and functions, including those related to monitoring and laboratory facilities; management of air, water, solid, and hazardous wastes; and environmental information. Many suggestions for restructuring the EPBs have already been adopted. For example, Tangshan EPB created several new divisions including Environmental Planning, Nature Resource Management, Environmental Management Information Center,19
17

The OEM was informed that the air pollution near the two ceramic and porcelain factories prior to the Project was so severe that the international consultants of the appraisal mission refused to get out of their vehicles upon arrival at the site. 18 The OEM was unable to obtain any health-related data for the factory employees, nor air pollution health statistics for Tangshan city such as incidence of respiratory diseases. 19 This center received CNY1 million from the Tangshan Municipal Government and a $150,000 grant from the Japanese Government. It has formed a local area network and Internet server system. With this hardware, the Center established an environmental information system, an environmental database system, a decision support system, and a geographical information system. These systems are playing an important role in Tangshans environmental management and improvement.

16 Environmental Monitoring Center,20 and Environmental Research Institute. Against the broader background in which the PRC Government is reducing its workforce, the fact that the Tangshan EPB was able to acquire additional funding for increased functions and workforce is being viewed by the Tangshan EPB as proof of the success of the TA. The OEM was informed that Chengde EPB also experienced a similar restructuring in accordance with TA recommendations. 49. Another important aspect of the TA was its provision of training and capacity-building opportunities for a group of 16 officials, 8 from each EPB, in the form of short-term overseas training. At the time of the OEM, both EPBs still had five participants working at senior positions. Although the overseas training was short, it gave valuable exposure for the two EPBs to environmental management in Australia, and has inculcated a sense of the importance of staff training. The Tangshan EPB has since organized domestic training for its staff on a regular basis. The OEM observed that the mid-level management team members of the Tangshan EPB are very knowledgeable in their fields and appear to be dedicated to their work. 50. Based on its observation, interviews, and comparisons with equivalent EPBs elsewhere in the PRC, the OEM reached the following assessment: The TA was highly relevant for the two recipient EPBs, which, like most other municipal EPBs in the PRC, were and still are the relatively weak link in the system, but they are often at the forefront of environmental law and regulation enforcement. The TA achieved its objective of strengthening the capabilities of the two EPBs. The results of the TA have been sustained, as the newly built departments and capacities have been well institutionalized. The TA, together with the Project, has raised the relative importance and profile of environmental protection in the TMGs agenda. Overall the TA is rated successful. Both the Tangshan and Chengde EPBs believe that the TA was a success, which they attribute largely to the good working relationship and close cooperation between the staffs of the EPBs and the consultant team. 51. Additional institutional impacts of the Project were achieved through a series of training activities conducted by the suppliers on the use and maintenance of the equipment procured under the Project. Almost every PIA visited had a group of people who were involved in the planning and execution of the Project and who later played a key role in operating the facilities. In terms of policy impact, ADBs loan covenants require full cost recovery for each subproject. Although this was not implemented in full, important progress is being made in adjusting wastewater tariffs to a full cost recovery level. However, the fundamental structure of most PIAs as SOEs remains unchanged, and prices are not set nor management decisions made on a commercial basis. V. OVERALL ASSESSMENT

52. A caveat may be warranted for the following overall assessment of the Project. The current Guidelines for the Preparation of Project Performance Audit Reports, approved in September 2000, is largely tailored to the context of single-investment projects. When applied to projects with several subprojects like this one, some conceptual and practical problems arise, as will be demonstrated below. This is mainly due to the fact that, for such projects with multiple PIAs
20

This center received $470,000 equivalent from the TMG to purchase a Ringelman smoke level auto-monitoring system, a pollution source on-line auto-monitoring system, and an air quality auto-monitoring system. The OEM visited its central control room and observed that the EPB officers can monitor the citys main stacks emission levels in the control room through a birds-eye camera. If and when unusually high emissions occur, the EPB can quickly dispatch a patrol officer to a site. Since its establishment, the center has served as a very useful tool for the TMG to ensure effective air quality monitoring and management.

17 and even being in multiple cities, the achievement of project outputs and purposes by different subprojects is largely independent of each other; some subprojects can achieve complete success, while others may suffer from catastrophic failure. The five building blocks of evaluation (relevance, efficacy, efficiency, sustainability, and institutional development and other impacts) may be conceptually and practically difficult to apply. The OEM adopted an approach of providing a rating for individual subprojects as well as an overall rating for the Project as a whole, but this is likely to only partly address the problems. A. Relevance

53. The Project was relevant at the time of appraisal in that it aimed to address the severe air and water pollution problems that plagued most PRC cities. It was also consistent with ADBs operational strategy in the PRC, in which environmental improvement has been one of the main pillars. Despite the significant improvement in environmental quality in many cities including Tangshan and Chengde, the relevance has not abated, as much remains to be done to further improve the environment. The Government continues to place high priority on and to commit increasing resources for this purpose. In terms of actual project formulation, the Project had six subprojects addressing energy efficiency/air pollution problems and one subproject addressing wastewater treatment, which reflected the urgency and priority of the environmental problems at the time and today. However, two of the seven subprojects (Subprojects 4 and 5) went beyond conventional environmental improvement technologies by financing high-risk ceramic and porcelain industrial projects, which failed. ADB has since exited from industrial projects with SOEs on energy efficiency and fuel conversion, and has focused more on achieving environmental improvement through working with public utilities in the areas of water supply, wastewater treatment, gas supply, etc. Subprojects 3, 4, and 5 were assessed as partly relevant, while the others were assessed as highly relevant. Overall, the Project is assessed as relevant. B. Efficacy

54. Of the seven subprojects, four, to a varying extent, have achieved both environmental improvement and economic benefits, and the remaining three have achieved some environmental improvement, but the impact on the financial and economic performance of the subproject enterprises has been either less positive or adverse, or even devastating. Subproject 1 (Gas Supply and Distribution), Subproject 2 (District Heating System), and Subproject 6 (Tangshan Wastewater Treatment Plant) have contributed significantly to the improvement of air and water quality in Tangshan. Subproject 7 (Chengde Coal Gasification Plant) contributed moderately to the improvement of air quality in Chengde since most gas produced is being consumed near the plant rather than in the city. 55. Subproject 3 (Coal Gasification Plants), which was to build and operate two coal gasification plants on the premises of two porcelain and ceramic factories, was partly implemented, with one such gasification plant built and the other one cancelled. However, the gasification plant at Tangshan No. 6 Ceramics Factory was operated for only 5 years before it was shut down when the municipal supply of gas, which is cheaper and safer, became available. Subproject 4 (Pollution Abatement at Tangshan No. 2 Porcelain Factory) and Subproject 5 (Pollution Abatement at Tangshan No. 6 Ceramics Factory) have experienced major problems with the installation, testing, and commissioning of imported equipment and, consequently, as of the OEMs visit, some items imported by the factories were never commercially commissioned.

18 56. The Project has substantially achieved its stated main objective of environmental improvement. However, the stated secondary objective, to introduce the most advanced and environmentally friendly technologies to maximize the beneficial impact on environment, and to have beneficial externalities in terms of industrial efficiency and product quality, was not achieved for Subprojects 4 and 5, nor, to a lesser degree, for Subproject 3. Subprojects 1 was assessed as highly efficacious, Subprojects 2, 6, and 7 as efficacious, Subproject 3 as less efficacious, and Subprojects 4 and 5 as inefficacious. Overall, the Project was assessed as less efficacious. C. Efficiency

57. The Project was generally implemented smoothly, with some delays for most subprojects. The overall recalculated EIRR is 14.7%, with EIRRs for individual subprojects ranging from negative to 17%. The overall recalculated FIRR for the Project was 8.5%, higher than the average cost of capital of 4.3%. However, even more so than in the case of the EIRR, there is significant variation in FIRRs across subprojects, with three ([3+5], and 4) having negative FIRRs and Subproject 6 having a FIRR lower than the average cost of capital. Subprojects 1, 2, and 7 were assessed as efficient; Subproject 6 as less efficient; and Subprojects 3, 4, and 5 as inefficient. Overall, the Project was assessed as less efficient. D. Sustainability

58. O&M of the project facilities was generally satisfactory. Some, e.g., the wastewater treatment plant, are facing more difficulties than others in operating and maintaining the imported equipment, as the cost is much higher and it takes longer to procure spare parts (compared with domestic equipment). In terms of financial viability, Subprojects 4 and (3+5) have negative FIRRs. The respective PIAs are also insolvent. Unless things change dramatically in terms of market and technological improvement of the project equipment, these three subprojects are presently not sustainable. Subproject 6 has a positive FIRR of 3.6% but lower-than-recalculated WACC, and the PIA has not achieved full financial breakeven. However, given the strong government policy and financial support, the subproject is likely to be sustainable. The other subprojects all have FIRRs significantly higher than their respective WACCs, and their PIAs have achieved financial breakeven at least against operating expenses. Subprojects 1 was assessed as most likely sustainable; Subprojects 2, 6, and 7 as likely; and Subprojects 3, 4, and 5 as unlikely. Overall, the Project is less likely to be sustainable.21 E. Institutional Development and Other Impacts

59. The Project, including the related advisory TA 1916, appears to have had a significant impact on the institutional development of the EPBs and PIAs. A large number of young and midage professionals and engineers were trained through the TA and/or through implementing the Project, and subsequently formed the backbones of their respective entities. The Project significantly raised the profile of the environment sector in the two cities overall development planning, which led to more investments and initiatives in subsequent years. Other social and development impacts include the health impact of air quality improvement, and the impacts on quality of life and real estate value. In terms of aggregate institutional and other impacts, Subprojects 1, 2, and 6 were assessed as substantial; Subproject 7 as moderate; and Subprojects 3, 4, and 5 as little. Overall, the impact is assessed as moderate.

21

The four categories are most likely, likely, less likely, and unlikely. Given the sustainability ratings for individual subprojects, a less likely rating is given to the overall Project. However, this should be interpreted somewhat differently, i.e., partly sustainable rather than less likely, since most subprojects are sustainable.

19 F. Overall Rating

60. Because of the diverse and relatively independent nature of the seven subprojects, ratings are given to individual subprojects as well as to the overall Project (Table 6). The overall rating of partly successful was given despite the high aggregated FIRR and EIRR to recognize the fact that the benefits and costs of different subprojects are not perfectly substitutable, not least because they accrued to different PIAs and even to different cities. The overall rating, which is lower than the PCRs successful rating, reflects the insolvency of the two PIAs in the case of Subprojects 3, 4, and 5, relatively low tariffs (compared to what is required to achieve breakeven) in the case of Subprojects 2 and 6, and not contributing significantly to the improvement of Chengdes air quality in the case of Subproject 7. Table 6: Subproject and Overall Project Ratings
Subproject/Project Subproject 1: Gas Supply and Distribution Network System Subproject 2: District Heating System Subproject 3: Coal Gasification Plants under the New Gas Company Rating Highly Successful Successful Partly Successful (Bordering Unsuccessful) Unsuccessful Unsuccessful Successful Successful Partly Successful (Bordering Successful)

Subproject 4: Pollution Abatement at Tangshan No. 2 Porcelain Factory Subproject 5: Pollution Abatement at Tangshan No. 6 Ceramics Factory Subproject 6: Tangshan Dongjiao Wastewater Treatment Plant Subproject 7: Coal Gasification Plant under the New Gas Company Project

G.

Assessment of Asian Development Bank and Executing Agency Performance

61. A total of 10 missions were fielded by ADB related to project preparation, implementation, and completion. The EAs and the PIAs are highly appreciative of successive ADB officers assistance at all stages; their dedication was credited by the EAs as a key factor in the relatively smooth implementation of the Project despite difficulties encountered. The EAs indicated that the ADB project officer was instrumental in helping select the subprojects. During implementation, ADB was generally very responsive in providing assistance in explaining ADBs guidelines on procurement and in approving the scope changes. The delays were largely caused by domestic procedures. However, the OEM is of the opinion that ADB should at least share responsibility for the essentially design failures associated with Subprojects 3, 4, and 5. The financial and operational viability and the difficulties of operating separate gasification plants at the ceramic and porcelain factories under Subproject 3 were not fully assessed. The underlying objective behind Subprojects 4 and 5 (not the stated one), i.e., to obtain the most advanced and environmentally friendly technologies, proved to be a risky strategy. The OEM also feels that the emphasis on the environmental nature of the Project was disproportionate to its intended and actual benefits and thus somewhat misleading.22 Lastly, in the case of Subprojects 4 and 5, ADB could have done more in terms of preventing the incidents from happening through, for example, providing advice to the PIAs on the potential risks of advance
22

For example, the Chengde Gasification Plant was referred to as a gasification plant in all ADB project documentation, while the PIA called it a coking plant. In reality, the sales from industrial coke are more than double that of gas, and yet the RRP referred to gas as the main product and coke as a by-product.

20 procurement by a year in order to avoid paying import tax, or helping the PIAs to identify the right type of expertise to install the equipment once the incidents occurred (para. 21 and footnote 9) Overall, ADBs performance is assessed as partly satisfactory. The performance of the EAs and PIAs was satisfactory. Despite difficulties, the EAs and PIAs showed very strong ownership of the Project, and the Project was mostly implemented as scheduled. TMG showed strong leadership in coordinating the execution of the Project. VI. A. ISSUES, LESSONS, AND FOLLOW-UP ACTIONS

Key Issues for the Future 1. Continued Support for SOEs to Achieve Public Goods?

62. The six PIAs were and continue to be either public utilities or SOEs. Although both are state-owned, the former refers to utilities providing water and gas distribution services, which have been traditionally provided by public entities, while the latter refers to state-owned industrial enterprises. A question was raised at loan formulation by Board members with respect to the wisdom of supporting SOEs directly rather than creating an enabling environment for them to access the capital market (para. 14). The question has relevance for ADBs current activities in the PRC (footnote 5). Despite the strong economic growth over the last 10 years, much of it spurred by new investments from the private sector (particularly from overseas), reforms in SOEs have been taking place in a piecemeal manner due to the implications for the society at large in terms of employment and social stability. Prices for essential commodities such as water and gas continue to be set by the Government. In terms of credit and financing, the SOEs, especially the better performing ones, are currently experiencing a period of easing credit and financing from domestic banks. As such, several PIAs informed the OEM that they would not consider borrowing from ADB again as long as domestic financing is available due to the latters more flexible and speedy approvals. 63. The experience of the Project appears to lend support to ADBs current operational strategy in the PRC, i.e., more focus on noncommercial sectors through public utilities to achieve public goods including water supply and wastewater treatment, gas supply, and district heating, and staying away from direct support to SOEs in essentially industrial projects even though the projects have positive repercussions for environmental/energy efficiency improvement. As demonstrated by Subprojects 4 and 5, the line between environmental improvement and industrial technology upgrading projects could be blurred, and the risks associated with industrial projects, both technological and market related, are much higher. The large amount of liquidity that exists in PRC domestic banks and their faster processing time make domestic funding more suitable for sound industrial projects, and ADB should not try to compete with and, thus, crowd out, domestic financing. 2. Integrated vs. Single-Investment Environmental Improvement Projects

64. Environmental improvement has become a mainstay of ADBs operations in the PRC. Integrated environmental improvement projects for a city like Tangshan have several advantages. First, through targeting use of resources for a city, as opposed to spreading to multiple cities, better developmental and environmental impacts may be achieved, since environmental improvement as well as economic development needs a certain threshold level to accumulate momentum. Second, it also implies more efficient processing from the staff inputto-impact point-of-view. Third, experiences can be easily shared, and were shared in this case, among various PIAs through the coordinating EA. On the other hand, multicomponent projects

21 also entail certain risks, as demonstrated by the Project. One such risk relates to mixing bad with good, thus affecting the overall project performance. Another such risk may be problems related to less-than-thorough appraisal and to administrative difficulties due to the more diverse scope. However, based on the experience of this particular Project, the OEM is inclined to believe that the benefits outweigh the risks (particularly from the borrowing countrys point of view), and, most importantly, the developmental impact achieved has the potential to be significant and cost efficient (with the exception of some subprojects). A point of concern relates to ADBs capability to think and act in a cross-sector manner. For example, presently wastewater treatment and water supply are part of the social sector divisions, while district heating and gas supply belong to the energy divisions, although they are within the same regional departments. The challenge for ADB is how to bridge this sector gap within itself in order to bring about greater impact with fewer resources. B. Lessons Identified 1. Choice of Technology: Suitable, Not Untested, Technology

65. One of the lessons learned from the Project is related to the selection of technologies at the project design phase. Under Subproject 4, the selection of an untested technology for producing high-quality porcelain, which was to be the second such production line in the world,23 was one of the main reasons for its failure in commercial production. Neither the PIA for the subproject nor the consultants nor even the supplier of the equipment had enough experience in building and operating such a production line. Both ADB and the PIA engaged separate technical experts to review the design, who provided positive assessment of the design and technology chosen. Perhaps partly due to the positive assessment made by these experts and partly because of the overemphasis on the environmental nature of the project, potential technological risks associated with the kiln technology were not explicitly discussed in the RRP.24 Despite the fact that ADB has exited from such industrial projects, choice of appropriate technology as a lesson learned continues to have its relevance, even in such well-developed fields as wastewater treatment. 2. Economic Benefits as a Prerequisite for Environmental Benefits

66. For a developing country like the PRC, achieving economic benefits (through improved quantity and quality of products/services) is a prerequisite for sustainable environmental improvement, and they are two sides of the same coin. In the course of project formulation and approval, ADB overemphasized the Projects environmental benefits while downplaying the economic gains. In contrast, the PIAs visited by the OEM were clearly much more concerned about the financial returns. A good example is Subproject 4: The PIA informed the OEM that the original plan was to use the ADB loan to procure a new gas-fired roller kiln to produce high-quality porcelainware. The PIA would then use the money generated from the new products to finance the conversion of its old coal-fired and oil-fired kilns to gas firing (para. 21). This highlights the dependence of environmental benefits on economic benefits of the subproject, but it was not mentioned in the RRP. For future environmental improvement projects, ADB should not try to de-emphasize the importance of achieving economic benefits in the process of achieving environmental improvement.

23 24

The first one was operating in Japan. The OEM recognizes that it is unreasonable to expect ADB staff to be experts on ceramic and porcelain.

22 3. Emphasis on Implementation

67. The Project once again highlights the importance of implementation and that developmental impact is not achieved at loan approval. At the time of loan implementation, the early to mid-1990s, ADB Management had initiated efforts to fight the approval culture within ADB and had placed increasing emphasis on project implementation. On the whole, the Projects implementation was satisfactory, given the strong performance of the EAs and PIAs, and ADB provided necessary and timely support. However, in the case of Subprojects 4 and 5, ADB could have done more in terms of preventing the incidents from happening through, for example, providing advice to the PIAs on the potential risks of advancing procurement by a year in order to avoid paying import tax, or helping the PIAs to identify the right type of expertise to install the equipment once the incidents occurred (para. 21 and footnote 9). The OEM was informed that the former employees demanded very high prices (although it was not clear how high), but in the end the PIA spent about half a million dollars hiring other expertise, which resulted in no success. There were other lessons regarding models for effective implementation. Successfully implemented subprojects appeared to share one common trait: strong participation by PIA staff. In the case of Subproject 7, for example, the Chengde Iron and Steel Company dispatched 600 engineers for training before and during the construction of the subproject; they have subsequently formed the backbone of the operating entity. C. Follow-Up Actions and Recommendations 1. Government and Project Implementation Agencies

68. Under the Loan Agreement, the Government is committed not to provide any subsidy or budgetary grant to any PIA after 1993. Furthermore, the Government was covenanted to ensure that utility enterprises set prices that allow full recovery of operating and capital costs and provide an adequate return on investment. These have not been fully complied with and should be heeded in a predetermined, phased manner. Compliance with these loan covenants is essential for the long-term sustainability of the Project and the environmental benefits it has brought about. 2. Asian Development Bank

69. As decisions on subsidies and prices are often made at higher level than PIAs and even municipal governments, ADB needs to continue its ongoing dialogue with the Government on water and gas tariff reforms. In this regard, ADB has provided substantial assistance in the area of tariff reforms for water supply and wastewater treatment (footnote 14), and more assistance may be warranted in gas tariff reforms. The reforms are also important to ensure the financial viability of ADBs ongoing and future environmental improvement projects.

Appendix 1

23

SUBPROJECT 1: GAS SUPPLY AND DISTRIBUTION NETWORK SYSTEM A. Project Purpose and Scope at Appraisal

1. The Report and Recommendation of the President did not specify a clear purpose for the subproject. However, based on the purpose of the overall Project and the scope of the subproject, it may be inferred that the subproject had a dual purpose: (i) air pollution reduction, and (ii) improving energy efficiency and quality of life. In the early 1990s, the Tangshan Gas Company was planning to expand its gas supply and distribution network to supply about 305,000 cubic meters per day (m3/day) of additional town gas (or coal gas, as it is commonly referred to in the Peoples Republic of China) to households and commercial establishments.1 The subproject was to provide the facilities needed to supply the incremental town gas so as to bring the total gas supply in Tangshan to about 670,000 m3/day. It would supply town gas to an additional 55,000 households and thus bring the total to 90% of the households in Tangshan. Major components were to include (i) installation of a 23.8-kilometer (km) medium-pressure pipeline network system; (ii) installation of a 36.3-km low-pressure pipeline network system; (iii) provision of two low-pressure gas holders, each with a 50,000-m3/day capacity gas compression and booster station; (iv) provision of two gas purification plants; (v) instrumentation; (vi) a control and monitoring system; and (vii) staff training. B. Achievement of Outputs

2. The subproject was largely implemented as envisaged, with minor delay and modifications. The main modification included cancellation of the planned Balizhuang Gas Purification Plant, as the incoming gas was already purified by the gas supplier, the Tangshan Iron and Steel Corporation. The money saved was used to partly finance the construction of a gas blending station (to mix low-heat waste gas from a ceramic factory with high-heat liquefied petroleum gas to meet the peak demand during winter. In addition to the two low-pressure gasholders at Zhaozhuang as envisaged, one more such gasholder of 50,000 m3/day was constructed at Banbidian in order to balance the daily demand fluctuation. The Operations Evaluation Mission confirmed that the quality of the equipment and installation was generally satisfactory. C. Cost and Scheduling

3. The actual cost of the subproject was $16.03 million according to the project completion report, consisting of $5.87 million in foreign exchange cost and $10.16 million equivalent in local currency cost.2 The cost overrun of 45.7% relative to the appraisal estimate of $11 million was attributable mainly to the construction of the gas blending station (not in the original scope) and one additional gasholder at Banbidian. 4. Commissioning was scheduled for December 1998, but actual commissioning took place in October 1999. A main reason was the procurement and construction of the additional gasholder and gas mixing station at Banbidian.

The town gas was to be purchased from the coke and gas-making plants of the Tangshan Iron and Steel Company and the Tangshan Coke Making plant, both of which were expanding their existing operations from their own resources. The total cost is slightly different from the number that the PIA provided to the OEM, i.e., $15.997 million, probably because of different exchange rates used.

24 D.

Appendix 1

Operational Performance

5. Since its commercial commissioning in October 1999, the subproject has increased the gas supplying capacity of the Project Implementation Agency (PIA) by 85% from 365,000 m3/day in 1993 to the present 670,000 m3/day. Table A1.1 indicates that gas sales have increased steadily since 1999, from 336,986 m3/day, or 50% of the design capacity, to 441,096 m3/day in 2003, or 66% of the design capacity. The number of households served grew from 149,000 in 1993 to 213,000 in 1999, and further to 271,000 in 2003, presently covering 96.5% of the households in the city and thus exceeding the target of 90%. An interview with a commercial customer (a hotel/restaurant) showed that it is highly satisfied with both the quality and price of the gas supply (compared with alternative energy sources such as electricity or heavy oil). The restaurant recently converted all of its fuel to gas, including cooking and air conditioning, in part because of the skyrocketing and highly fluctuating prices of diesel, which it used for air conditioning. Overall, the subproject contributed significantly to the improvement of Tangshans air quality. The PIA estimated that in 2003, compared with the baseline 1993 level, it reduced sulfur dioxide emissions by 4,200 tons (compared with the 4,340-ton target at appraisal), total suspended particulates by 6,510 tons (compared to the target of 6,510 tons). Table A1.1: Operational Performance Indicators of Tangshan Gas Company Annual Gas Sale (million m3) 123.0 128.0 128.0 156.0 161.0 Daily Average Sale (m3) 336,986 350,685 350,685 427,397 441,096 As a % of the Design Capacity 50% 52% 52% 64% 66% No. of Households Served 213,000 232,000 246,000 262,000 271,000 Service Coverage 90.0% 91.0% 93.1% 94.7% 96.5%

Year 1999 2000 2001 2002 2003

m3 = cubic meter. Source: Tangshan Gas Company.

E.

Performance of the Operating Entity

6. Table A1.2 provides the financial tables of the Tangshan Gas Company. It indicates that total sales increased steadily from CNY38.37 million in 1995 to CNY138.09 million in 2003, averaging 17% per year. From 1999 (when the subproject was commissioned) to 2003, the growth rate was 14% per annum. In other words, there was no acceleration of the growth rate after the subproject was commissioned. Furthermore, despite more than three times growth in sales and in net fixed assets partly due to the subproject, the PIAs profitability, both before and after tax, has not improved significantly. In 2003, it made a modest before-tax operating profit of CNY7.81 million, with a return on net fixed assets at 4.8%.3 During 2001 and 2002, the PIA could not service its debt.4 The debt service ratio in 2003 was only 0.18 and did not meet ADBs loan covenant of at least 1.3. The PIA had enough cash reserve from 2001 and 2002 to service its debt. Overall the PIA is in a good cash flow situation with a positive cash reserve of CNY81 million at the end of 2003. However the long-term cash flow situation, is
3 4

Although a rate of return of 8% or higher is considered sound, the ADB loan did not include a covenant for this. The Tangshan Government has a flexible policy on meeting the debt-service requirement for subproject enterprises. If the financial performance of an enterprise is not good, it will allow the taxes it pays for the year to be swapped for debt servicing.

Appendix 1

25

uncertain, since the gas business does not seem to generate enough cash to service the debt. The debt-equity ratio since 2001 has been around 78:22, meeting the Asian Development Bank (ADB)-covenanted level of 80:20 or lower. F. Overall Assessment

7. Using ADBs five building blocks of evaluation, the subproject is assessed as highly relevant, highly efficacious, efficient, most likely to be sustainable, with substantial institutional development and other impacts. Overall, the subproject is rated as highly successful.

26

Appendix 1

Table A1.2: Financial Performance of Tangshan Gas Company 19952003 (CNY million)
Year Ending December 31 Income Statements Sales Less: Cost of Sales Gross Profit Other Operating Income Less: Total Operating Expenses Selling Expenses Administrative Expenses Operating Income Less: Financial Expenses (income) Non-Operating Income/(Expense) Other Adjustments Net Income Before Tax Net Income After Tax Cash Flow Statements Net Income After Tax Add: Non-Cash Charges Interest Expense Internal Cash Generation Borrowings Equity Contributions and Grants Received Proceeds from Investments Other Local Sources Total Sources of Funds Capital Expenditures Debt Service Other Payments Change in Working Capital Total Application of Funds Changes in Cash Cash Balance, Beginning of Year Cash Balance, End of Year 1995 38.37 35.00 3.37 5.05 1996 49.74 42.84 6.90 7.02 1997 60.97 50.93 10.04 9.77 1998 61.52 53.99 7.54 11.61 1999 81.61 64.69 16.92 15.02 2000 95.77 81.54 14.23 16.96 2001 96.45 84.32 12.13 7.18 18.48 1.96 16.51 0.84 (1.47) 0.41 2.71 1.82 1.82 17.03 (1.47) 17.38 0.00 0.32 2.16 52.38 36.39 1.96 14.43 52.77 (0.39) 7.99 7.59 11.48 42.05 52.94 4.63 4.14 27.63 28.00 7.32 1.74 21.35 27.48 1.64 1.88 43.01 29.57 10.29 92.71 125.77 17.29 8.21 81.69 107.19 18.58 62.04 80.62 24.26 (6.55) 80.62 74.07 4.88 34.67 74.07 108.74 42.96 (27.29) 108.74 81.45 17.71 21.26 0.00 3.00
a

2002 119.07 98.23 20.84 5.59 20.87 2.60 18.27 5.55 (1.49) (0.80) 6.24 1.47 1.47 32.51 (1.49) 32.50 6.70 0.35 39.55 4.88 0.00 0.00
a

2003 138.09 114.97 23.12 7.54 22.03 0.01 22.02 8.63 (1.67) (2.49) 7.81 2.13 2.13 2.21 (1.67) 2.67 10.00 1.21 1.79 15.67 8.76 15.00 19.20

(1.68) (0.90) 2.73 1.96 1.96 1.96 5.66 7.62 42.60

(0.12) (1.58) 3.17 4.63 4.63 4.63 7.04 11.66 18.91

0.27 (1.00) 6.05 7.32 7.32 7.32 5.40 12.73 10.77

(4.08) (2.46) 3.62 0.45 2.45 1.64 1.64 5.76 7.40 12.21

1.89 (0.59) 3.76 (3.13) 3.12 2.09 2.09 7.06 9.14 31.98

(2.73) (1.83) 4.21 0.07 3.37 2.26 2.26 13.64 15.90 17.16

(28.72) (22.89) 28.85 13.19 7.59 20.79 12.43 15.20 20.79 35.98

(9.02) (21.67) 20.10 1.24 35.98 37.22 18.19 24.82 37.22 62.04

Appendix 1

27
2003 192.87 81.45 27.16 49.12 35.14 22.97 301.44 126.35 175.09 20.05 4.72 415.70 155.22 9.34 10.00 135.88 55.41 11.28 193.79 73.95 119.84 415.70 4.83 0.18 22.23

Year Ending December 31 Balance Sheets Current Assets Cash and Deposits Accounts Receivable, net Inventories, net Other Current Assets Long-Term Investments Fixed Assets Less: Accumulated Depreciation Fixed Assets, net Construction in Progress Other Assets Total Assets

1995 53.09 7.59 11.12 26.59 7.79 0.05 110.71 54.76 55.95 41.03 0.00 150.12

1996 46.28 20.79 11.07 7.25 7.17 0.15 115.18 61.80 53.38 89.41 0.00 189.22 15.75 1.99 13.76 88.30 85.17 68.07 17.10 189.22 (0.23) 2.52 50.90

1997 83.89 35.98 25.78 15.88 6.25 0.62 117.77 67.20 50.57 113.37 0.97 249.42 61.05 11.96 0.00 49.10 99.06 89.31 68.07 21.24 249.42 0.52 1.74 52.59

1998 74.21 37.22 17.44 19.31 0.25 0.68 126.13 72.96 53.17 132.41 1.00 261.47 59.16 11.06 5.00 43.09 111.27 91.05 68.07 22.98 261.47 (7.86) 4.51 55.00

1999 107.06 62.04 18.16 21.31 5.55 0.63 195.54 80.01 115.53 92.68 0.94 316.83 86.88 4.91 0.00 81.96 137.02 92.93 68.07 24.86 316.83 2.24 0.89 59.59

2000 162.42 80.62 37.16 37.38 7.25 0.77 219.59 93.65 125.94 76.89 0.82 366.82 122.05 9.86 15.00 97.20 62.89 181.88 76.98 104.90 366.82 (2.26) 1.94 25.69

2001 171.97 74.07 37.26 43.74 16.89 3.77 270.52 104.22 166.30 44.90 1.84 388.77 135.36 6.27 15.00 114.09 55.41 5.77 192.24 76.98 115.26 388.77 0.57 n.a. 22.37

2002 206.65 108.74 22.26 40.68 34.98 3.77 296.11 113.61 182.50 17.19 5.38 415.48 156.41 9.97 15.00 131.44 55.41 9.96 193.71 73.95 119.76 415.48 3.18 n.a. 22.24

Current Liabilities 7.03 Accounts Payable 2.85 Short-Term Loans 0.00 Others 4.19 Long-Term Debt 69.39 Other Long-Term Liabilities Equity 73.70 Paid-in Capital 68.07 Surplus, Reserves, and Retained Earnings 5.63 Total Liabilities and Equity 150.12 Financial Indicators Return on Net Fixed Assets (%) b Debt-Service Coverage Ratio (times) c Debt/Debt Plus Equity (% of debt) d
a

(3.00) 3.90 48.50

n.a. = not available. Debt servicing during 2001-2002 was not by cash but through swapping tax payments for partial debt servicing. No actual figures were available. b Net operating income after taxes as a percentage of average net fixed assets in operation. c Ratio of internal cash generation to annual debt service. d Ratio of long-term debt to long-term debt plus equity. Note: Accounts are for the consolidated operations of the company. Cash flow statements have been reconstructed from available accounts. Source: Tangshan Gas Company.

28

Appendix 2

SUBPROJECT 2: DISTRICT HEATING SYSTEM A. Project Purpose and Scope at Appraisal

1. The Report and Recommendation of the President did not specify a clear purpose for the subproject. However, based on the purpose of the overall Project and the scope of the subproject, it may be inferred that the subproject had a dual purpose: (i) air pollution reduction, and (ii) improving energy efficiency and quality of life. Under the subproject, the Asian Development Bank (ADB) was to finance the installation of a pipeline network system for the transmission and distribution of heat for the district heating system. The heat was to be generated by the Xijiao Cogeneration Power Plant, which was to be financed from domestic resources and completed in two phases, in 1994 and 1997. The subproject would supply space heating to about 8.5 million square meters (m2) consisting of 4.93 million m2 of residential space and about 3.57 million m2 of space in commercial establishments and public buildings. This would satisfy almost 100% of the heating requirement of the western section of the central district of Tangshan. Major components were to include (i) electrical equipment, (ii) heat exchangers, (iii) instrumentation and control, (iv) computer-based heat supply, (v) control and monitoring system, (vi) water treatment facilities, (vii) installation of a 29.5 kilometer (km) pipeline network system, and (viii) staff training. B. Achievement of Outputs

2. The subproject was implemented as envisaged with respect to the heat distribution network and all associated facilities with some modifications. The modifications included (i) construction of 33.5 km of pipeline compared with the appraisal estimate of 29.5 km; (ii) 12 sets of radio signal transmission equipment, used for communications between the central control and the heat exchange stations, procured instead of 85 sets as envisaged by the original design and strongly advocated by the international consultants;1 and (iii) reduction in the number of sets of computer-based control equipment from 2 to 1 (to cover only the western district system) in order to save costs by continuing to make use of the existing control equipment for the central district. Since the completion of the Project, significant additions have been made, using the Project Implementation Agencys (PIA) own funding, to improve the service coverage and the quality of service. These included (i) procurement of 6 km of additional pipeline, necessary to serve the new residence area developed during 19982003, bringing the total length of the pipeline network to 39.5 km, (ii) establishment of a Pressure and Temperature Reduction Station at the Xijiao Cogeneration Power Plant in order to acquire an additional 1.3 million gigajoules per year of heat from the cogeneration plant. The Operations Evaluation Mission (OEM) confirmed that the quality of construction was satisfactory to excellent. The engineering and civil works were generally done in accordance with international standards. Special compliments were given by PIA officials to the high quality manual and automatic valves, the heat exchangers, and the high reliability of the network control system, supplied by both foreign and Peoples Republic of China (PRC) contractors.

There was a strong disagreement between the international consultants, who insisted that 85 sets were necessary to achieve safe operation and operational efficiency, and the Project Implementation Agency, which felt that the costs were too high and the function of the radio equipment could be performed (without compromising safety) by its surplus labor.

Appendix 2

29

C.

Cost and Scheduling

3. The OEM confirmed that the project completion report cost estimates were correct. The actual cost of the subproject was $40.15 million, consisting of $16.94 million in foreign exchange cost and $23.21 million equivalent in local currency cost. In addition to strong competition among suppliers, the reduction in procurement of radio signal equipment and computer control facilities contributed to the cost underrun of about 30%, relative to the appraisal estimate of $57 million, in both foreign exchange and local currency costs. 4. The actual commission time was January 1998, almost one year ahead of the original scheduled time of December 1998. D. Operational Performance

5. Although the subproject was implemented as envisaged, with some modifications, the heat source was not established as planned (the heat capacity of the heat source in the Xijiao Cogeneration plant in 2001 was only half of the original design capacity). Therefore, the distribution network was operating at half capacity. Since then, the PIA has actively searched for an alternative heat source to make up the shortfall. Four measures have been or will be taken, using its own resources. First, it has installed a main pipeline to link the West District heating system to the Central District heating system. This pipeline linkage temporarily provided about 1.05 million square meters (m2) of space equivalent of heat to the West District heating system from 2001 to 2002. Second, it established a Pressure and Temperature Reduction Station in the Xijiao Cogeneration Plant in 2003 to directly use the steam from the No. 3 utility boiler in the cogeneration plant. This has supplied an additional 2.55 million m2 equivalent of heat to the West District heating system. The first two measures have enabled the distribution network to reach 91% of its design capacity. Third, it has secured heat from a 200 megawatt cogeneration unit in the Xijiao Cogeneration Power Plant, which is under construction and is scheduled to be commissioned in 2005. Fourth, it will establish 22 additional heat exchange stations during 2005 and 2006 to keep pace with the citys development in the West District. The OEM believes that, with the measures already taken and the firm evidence that more measures are being or will be taken, the heating system will achieve its design capacity of 8.5 million m2 by 2006. 6. The subproject has contributed significantly to the improvement of Tangshan air quality through eliminating 220 boilers, 136 stacks, and more than 100,000 coal-fired household stoves. In terms of emission reduction, the PIA estimated that in 2003 the subproject reduced sulfur dioxide emissions by 2,650 tons (compared with the target of 5,750 tons), and total suspended particulates by 44,200 tons (compared with the target of 96,000 tons). E. Performance of the Operating Entity

7. The financial tables for the Tangshan Heat and Power Company (Table A2) indicate that total sales increased from CNY86.71 million in 1995 to CNY203.65 million in 2003, averaging 11% per year. From 1998 (when the subproject was commissioned) to 2003, the growth rate was nearly 15%. It appears that the subproject has significantly enabled the PIA to meet growing demand, and the system has reached 91% of the design capacity. However, although the fast-growing sales numbers have probably been responsible for the net operating income turning positive since 2002, they have not translated into higher overall profitability, with net income before tax decreasing to CNY2.31 million in 2003 from CNY3.23 million in 1995, in part because of declining non-operating income. Unlike the Tangshan Gas Company which used 66% of its capacity in 2003, capacity utilization for the Tangshan Heat and Power

30

Appendix 2

Company has already reached 91%. The low profitability indicates either that tariffs, currently CNY15.93/m2 per year for industrial customers and CNY17.70/m2 per year for households, are low or there is significant room for cost cutting. For example, while total sales between 1995 and 2003 increased by 2.36 times, total operating expenses during the same period increased faster than sales by 2.56 times. In 2003, it had a staff of 2,700, and the OEM estimated about 800 people worked to operate and maintain the subproject facilities. This yields a ratio of 9,669 m2 per staff member, much lower than world levels and even lower than the PRC average.2 The returns on net fixed assets for 2002 and 2003 were very low at less than 1%, although the PIA has been in a position to service its debt, with the average debt-service coverage ratio at 1.64 (exceeding the ADB-covenanted level of 1.3). However, the long-term cash flow situation is uncertain, since the heating business does not seem to generate enough cash to service the debt, unless there will be significant increases in prices and/or cost cutting measures. The debt-equity ratio since 1999 has been around 60:40, meeting the ADBcovenanted level of 80:20 or lower. F. Overall Assessment

8. Using ADBs five building blocks of evaluation, the subproject is assessed as highly relevant, efficacious, efficient, likely to be sustainable, with substantial institutional development and other impacts. Overall, the subproject is rated as successful.

The PRC has an average of 10,000-12,000 m2 per staff member, while in the West this ratio could be 10 times higher.

Appendix 2

31

Table A2: Financial Performance of Tangshan Heat and Power Company 19952003 (CNY million)
Year Ending December 31 Income Statements Sales Less: Cost of Sales Gross Profit Other Operating Income Less: Total Operating Expenses Selling Expenses Administrative Expenses Operating Income Less: Financial Expenses (income) Non-Operating Income/(Expense) Other Adjustments Net Income Before Tax Net Income After Tax Cash Flow Statements Net Income After Tax Add: Noncash Charges Interest Expense Internal Cash Generation Borrowings Equity Contributions and Grants Received Proceeds from Investments Other Local Sources Total Sources of Funds Capital Expenditures Debt Service Other Payments Change in Working Capital Total Application of Funds Changes in Cash Cash Balance, Beginning of Year Cash Balance, End of Year 1995 86.71 83.99 2.72 6.58 1996 86.94 80.94 6.00 6.80 1997 101.63 93.17 8.46 9.80 1998 102.33 99.79 2.54 11.08 1999 146.28 136.03 10.25 14.84 2000 159.72 145.46 14.26 13.83 2001 167.86 153.77 14.09 15.19 2002 185.62 168.31 17.31 16.61 2003 203.65 185.62 18.03 16.86

(3.86) (1.31) 4.04 1.74 3.23 2.74 2.74 11.35 14.09 8.92

(0.80) (1.45) 4.19 4.84 3.24 3.24 10.11 13.35 3.79

(1.34) (1.82) 3.79 4.27 2.86 2.86 14.91 17.77 12.64

(8.54) (3.26) 5.86 0.03 0.61 0.39 0.39 53.15 (3.26) 50.28 1.00 0.11

(4.59) (2.10) 5.07 0.00 2.58 1.62 1.62 40.52 (2.10) 40.04 264.14

0.43 (1.94) (0.46) 0.00 1.91 1.28 1.28 12.96 (1.94) 12.30

(1.10) (1.48) 2.05 2.43 0.56 0.56 32.06 32.62

0.70 (0.79) 1.27 2.76 0.75 0.75 43.56 (0.79) 43.52

1.17 0.73 1.87 2.31 0.36 0.36 38.15 3.12 41.63 30.00 0.47 72.09 43.97 38.04 17.00

0.18 304.18 300.23 40.32 (109.90) 12.48 5.00 9.81 32.62 2.97 14.88

0.04 43.56 54.55 19.06 40.75

0.02 23.03 47.27 0.00

6.28 23.42 73.19 6.18

30.41

51.39 3.86 34.70 0.01

32.70 2.02 27.10 (26.49) (69.04) (39.90) 20.78 2.25 11.76 14.01 10.33 13.09 14.01 27.10 21.92 8.49 27.10 35.59

38.57 12.82 35.59 48.41

230.65 73.53 48.41 121.94

14.81

17.85

114.36

99.01

(2.32) 14.77 121.94 119.62 119.62 134.39

(70.80) (26.91) 134.39 60.80 60.80 33.89

32

Appendix 2

Year Ending December 31 Balance Sheets Current Assets Cash and Deposits Accounts Receivable, net Inventories, net Other Current Assets Long-Term Investments Fixed Assets Less: Accumulated Depreciation Fixed Assets, net Construction in Progress Other Assets Total Assets

1995

1996

1997

1998

1999

2000

2001

2002

2003

95.93 14.01 7.33 8.55 66.04 313.04 191.08 121.96 23.72 1.55 243.16

133.43 27.10 8.62 16.42 81.29 372.53 204.41 168.12 1.37 1.57 304.49 110.85 0.22 17.60 93.03 34.14 159.50 151.69 7.81 304.49 (0.55) 2.16 17.63

163.89 35.59 2.04 17.96 108.30 364.25 212.84 151.41 1.72 1.45 318.47 118.52 0.74 19.20 98.58 46.78 153.17 144.52 8.65 318.47 (0.84) 8.80 23.40

144.20 48.41 7.58 14.36 73.85 380.65 223.08 157.57 3.70 1.48 306.95 117.63 0.49 0.00 117.14 29.31 160.01 150.94 9.07 306.95 (5.53) 1.45 15.48

168.90 121.94 4.36 12.24 30.36 682.38 261.50 420.88 2.55 1.13 593.46 173.24 0.71 0.00 172.53 259.65 160.57 150.94 9.63 593.46 (1.59) 0.99 61.79

208.33 119.62 3.03 13.67 72.01 678.58 290.72 387.86 5.39 1.11 602.69 185.31 0.24 0.00 185.07 255.78 161.60 150.94 10.66 602.69 0.11 1.25 61.28

239.35 134.39 1.73 16.94 86.29 679.75 319.26 360.49 15.30 1.07 616.21 208.88 0.22 0.00 208.66 251.53 155.80 150.94 4.86 616.21 (0.29) 10.98 61.75

135.04 60.80 2.28 9.39 62.57 697.41 345.55 351.86 121.07 41.82 649.79 245.10 5.56 0.00 239.54 218.71 29.36 156.62 150.94 5.68 649.79 0.20 2.28 58.27

175.96 33.89 2.24 10.14 129.69 743.00 374.06 368.94 59.75 58.82 663.47 265.59 3.77 0.00 261.82 212.33 28.57 156.98 150.94 6.04 663.47 0.32 1.09 57.49

Current Liabilities 56.65 Accounts Payable 0.31 Short-Term Loans 0.00 Others 56.34 Long-Term Debt 30.35 Other Long-Term Liabilities Equity 156.16 Paid-in Capital 145.41 Surplus, Reserves, and Retained Earnings 10.75 Total Liabilities and Equity 243.16 Financial Indicators Return on Net Fixed Assets (%) a Debt-Service Coverage Ratio (times) b Debt/Debt Plus Equity (% of debt) c
a b c

(3.16) n.a 16.27

Net operating income after taxes as a percentage of average net fixed assets in operation. Ratio of internal cash generation to annual debt service. Ratio of long-term debt to long-term debt plus equity.

Note: Accounts are for the consolidated operations of the company. Cash flow statements have been reconstructed from available accounts. Source: Tangshan Heat and Power Company.

Appendix 3

33

SUBPROJECT 3: COAL GASIFICATION PLANTS UNDER THE NEW GAS COMPANY A. Project Purpose and Scope at Appraisal

1. The Report and Recommendation of the President did not specify a clear purpose for the subproject. However, based on the purpose of the overall Project and the scope of the subproject, it may be inferred that the subproject had a dual purpose: (i) air pollution reduction, and (ii) improving energy efficiency for the subproject enterprise. Under the subproject, two coal gasification plants, one on the premises of Tangshan No. 2 Porcelain Factory and the other at Tangshan No. 6 Ceramic Factory, were to be established and operated by the Tangshan Ceramic Industrial Coal Gas Company, Ltd. (a new gas company) to supply gas to the ceramic kilns at these two factories. The gasification plant at Tangshan No. 2 Porcelain Factory was designed to produce about 288,000 cubic meters (m3) of gas per day with heating value of about 6,000 kilojoules per m3. As an auxiliary plant, a wastewater treatment plant was to be constructed with a capacity to process 7,800 m3/day of industrial wastewater, of which about 6,920 m3/day of the treated water was to be recycled to meet 88% of the plants total requirements. The gasification plant at Tangshan No. 6 Ceramic Factory was to produce gas at 144,000 m3/day, of which 100,800 m3/day was to provide pollution abatement work at the two kilns also financed under the Loan (see Subprojects 4 and 5), with the balanced supplied to the third kiln financed by the factory. Major components of the subproject for each site included (i) a coal preparation plant, (ii) a gasmaking plant, (iii) wastewater treatment facilities, (iv) a pipeline system, and (v) staff training. B. Achievement of Outputs

2. The planned gasification plant for Tangshan No. 2 Porcelain Factory was cancelled, as the factory was able to secure its gas supply from Tangshan Gas Company (benefiting from the increased gas-supplying capacity financed under Subproject 1). A gasification plant was constructed as envisaged on the premises of Tangshan No. 6 Ceramic Factory. C. Cost and Scheduling

3. The Operations Evaluation Mission (OEM) could not independently confirm the project completion report (PCR) cost estimates, in part because the subproject was procured together with Subproject 5 by the same Project Implementation Agency (PIA) (paras. 34 and 37 of the main text). The actual cost of Subproject 3, according to the PCR, was $3.55 million, consisting of $2.54 million in foreign exchange cost and $1.01 million equivalent in local currency cost. This represents an 80% cost underrun, the main reason being, in addition to competition among suppliers, cancellation of half of the subproject and over-budgeting by ADB. The PIA provided the cost figures to the OEM for combined Subprojects 3 and 5, which was $23.23 million, including $14.69 million in foreign exchange cost (funded by the Asian Development Bank [ADB]) and $ 8.54 million equivalent in local currency cost. These figures are slightly higher than the combined costs of Subprojects 3 and 5 as estimated by the PCR. 4. Mainly due to the cancellation of half of the scope, the actual commissioning time was 2.5 years ahead of schedule in June 1996. D. Operational Performance

5. The gasification plant built on the premises of Tangshan No. 6 Ceramic Factory was operated safely for 5 years between 1996 and 2001 before it was shut down, and has contributed significantly to environmental improvement in Tangshan. All 15 stacks and

34

Appendix 3

associated coal-fired kilns were demolished. However, since 2002, the factory was also connected to the city gas supply due to the increased gas-supplying capacity benefiting from Subproject 1, cheaper costs, and safety concerns (as there are potentially high health and safety risks associated with operating an in-situ gasification plant). The OEM inspected the idle gasification plant. Although the plant manager claimed that it was in working condition, the facilities were not mothballed, and rust was visible. The OEM was informed that the PIA was trying to sell the facilities, perhaps to an industrial customer in a far away location without access to the city supply of gas. However, the OEM feels that the chances of finding a customer that can operate the plant safely are diminishing rapidly as time goes by. 6. The PIA estimated that, during the 5 years of operation, the gasification plant achieved its intended environmental targets, i.e., sulfur dioxide emission reduction of 500 tons per year and total suspended particulates reduction of 338 tons per year. In addition, a large reduction of coal slag was achieved. E. 7. F. Performance of the Operating Entity See the same section for Subproject 5 (Appendix 5). Overall Assessment

8. Using ADBs five building blocks of evaluation, the subproject is assessed as partly relevant, less efficacious, inefficient, unlikely to be sustainable, with little institutional development and other impacts. Overall, the subproject is rated as partly successful, bordering unsuccessful.

Appendix 4

35

SUBPROJECT 4: POLLUTION ABATEMENT AT TANGSHAN NO. 2 PORCELAIN FACTORY A. Project Purpose and Scope at Appraisal

1. The factory, established in 1952, was operating five coal-fired tunnel kilns, two push-slab kilns, and six heavy oil-fired roller kilns. The production facilities were located in the main residential area of the city and caused severe air pollution. Due to outdated technology, stoking and tapping of coal in the tunnel were undertaken manually, which not only constituted a health hazard but resulted in intermittent heat supply to the kilns. Energy efficiency in these coal-fired kilns was only about 7.2%. 2. The Report and Recommendation of the President (RRP) did not specify a clear purpose for the subproject. However, based on the purpose of the overall Project and the scope of the subproject, it may be inferred that the subproject had a dual purpose: (i) air pollution reduction, and (ii) improving the energy efficiency and quality of porcelain products. Under the subproject, all five coal-fired kilns were to be demolished and seven new gas-fired kilns were to be established. All six heavy oil-fired roller-kilns were to be converted to gas. Two new gas-fired roller kilns were to be established, with one financed under the subproject and the other financed from the factorys own resources. The two push-slab kilns were to be demolished without replacement. Overall, there would be no increase in production capacity, and gas to these kilns was to be supplied from the coal gasification plant under Subproject 3. Major components included (i) provision of equipment and machinery, (ii) instrumentation and control, and (iii) staff training. B. Achievement of Outputs

3. Although the components under the subproject were mostly implemented as of the Operations Evaluation Missions (OEM) visit, they were not done in the manner and sequence originally intended. The original intention, at least from the Project Implementation Agencys (PIA) point of view, was to use the Asian Development Bank (ADB) loan to procure a new gasfired roller kiln to produce high-quality porcelainware, which was in high demand by the international market at profitable prices. The PIA would then use the money generated from the new products to finance the conversion of its old coal-fired and oil-fired kilns to gas firing. As it happened, the new gas-fired roller kiln was established using ADB loan proceeds. However, due to various problems related to poor design, adoption of untested technology, and the contractors poor performance, the kiln equipment was never commercially commissioned after several failed trials. The products it produced were of unstable quality in terms of size and color, and could not meet the quality standards set by the intended export markets. As a result, after some limited test production in the first 2 years of completion, the equipment has been idle since 2002. Another major item procured using ADB loan proceeds was molding equipment.1 The equipment was designed to produce 7 million molded clayware annually to match the capacity of the kiln. However, due to the sudden bankruptcy of the German supplier after the equipment arrived at site, the supplier did not dispatch any staff to install, adjust, or test it or to train local staff as required by the contract.2 Strong efforts made by the PIA to invite the suppliers former employees to complete the work with additional payment failed due to the very high prices demanded by the technicians.
1

Molding is the preprocessing in porcelain production, which results in molded, half-dried clayware for kilns to bake to produce the final porcelain. According to the PIA and Executing Agency officials interviewed, the molding equipment was procured in advance in an effort by the PIA to avoid paying import tax, which was to be introduced by the Government the following year.

36

Appendix 4

4. The nonperformance of the new kiln and the molding equipment in terms of cash generation seriously delayed the conversion of the old kilns. As such, at loan closing in 2000, the work had not even started. However, the PIA subsequently completed the conversion using its own funding. Of the five coal-fired kilns, three were modified for gas-based combustion (with a combined capacity equivalent of that of the previous five coal-fired kilns), one was retrofitted with a bag-house dust collector, and one was demolished without replacement. The six oil-fired kilns were also converted to gas. C. Cost and Scheduling

5. According to the project completion report (PCR), the actual cost of the subproject was $17.98 million, consisting of $8.12 million in foreign exchange cost and $9.86 million equivalent in local currency cost. However, these cost estimates are somewhat lower than the figures provided to the OEM by the PIA, which were $19.08 million for the total cost, including $9.15 million in foreign exchange cost (funded by ADB) and $9.33 million equivalent local currency cost. The difference of $1.1 million in total cost was unaccounted for but likely caused by several factors. In addition to exchange rates and accounting inconsistency or errors, the issue of what constituted the subproject may also play a role, since some of the components were financed using the PIAs own resources after the loan was closed, and part of costs may have been erroneously included in the latest cost figure provided to the OEM. Assuming that the PCR estimates are correct, there was a significant cost saving of about 14.4% compared with the appraisal estimate of $21 million. In addition to strong competition among suppliers, the delay in renovation of the five existing coal-fired kilns (estimated cost of $2.65 million) until after the loan was closed was the main factor for the cost underrun. 6. The actual commercial commission time was indicated as April 1998, 9 months ahead of schedule. However, the kilns and the molding equipment never passed the test run stage, and were never fully commercially commissioned. D. Operational Performance

7. The gas-fired kiln was the primary component financed using ADB loan proceeds. It included two kiln furnaces of about 40 meters long. The primary furnace was to be used to make biscuit porcelain, and the secondary furnace to make glazed porcelain. The furnaces were designed to produce 7 million pieces of high-quality porcelainware annually in order for the No. 2 Porcelain Factory to have the financial strength to renovate its five existing coal-fired kilns. The performance test for the gas-fired kiln was delayed by the vender, a United Kingdom-based company, but later on carried out. However, the test runs could not produce the specified highquality porcelainwares. Later adjustments by the vendor showed some improvement in operation, but it was not enough to solve the problem.3 The supplier eventually withdrew from the site without meeting performance specifications. The OEM was informed that, before the subproject, there was only one kiln of this type in the world operating successfully (in Japan). The strategy as set out at appraisal to select the the most advanced and environmentally friendly technologies failed.4 The second major piece of equipment procured under ADB loan was also never commercially operational due to sudden bankruptcy of the supplier.

The problem appeared to be that the kiln could not maintain a section in an oxygen-deficit environment (carbon monoxide rich) as it was designed. Subsequently, the PIA has made various efforts to engage domestic and overseas companies to adjust the equipment, but without success.

Appendix 4

37

8. Despite the severe setback in terms of economic losses of the ADB-financed component,5 the other components of the subproject, i.e., conversion of coal-fired and oil-fired kilns to gas, were eventually built although not under ADB financing. The conversion has contributed to the marked improvement of Tangshans air quality. The PIA estimated that in 2003 reduction of about 500 tons of sulfur dioxide emissions and 338 tons of total suspended particulates emissions was achieved as targeted at appraisal. E. Performance of the Operating Entity

9. Table A4 provides the financial tables for Tangshan No. 2 Porcelain Factory. An asset restructuring at the completion of the subproject allocated ADB-financed assets to the PIA while leaving all the existing assets prior to the subproject to a joint venture company between a Hong Kong group and the Tangshan Municipal Government. Therefore, the financial tables as provided are only for the performance of the new Tangshan No. 2 Porcelain Factory, which comprises entirely the ADB-financed assets, and are only for after 1999 (the subproject started commercial operation in 1998). 10. The income statements indicate that the total sales fluctuated at a very low level, and in 2003, were down to CNY1.35 million from CNY3.91 million in 1999. The reason, as discussed, was that the equipment procured under the subproject was never fully tuned to produce quality products that met the export market standards. The current sales figures were mostly the results of the piecemeal sale of substandard products. Similar to the case of No. 6 Ceramic Factory, the PIA, with net fixed assets of CNY16.3 million in 1995 (prior to the subproject) according to the RRP, was able to acquire a loan of $8.12 million (or CNY67.4 million) from ADB and $9.86 million equivalent (or CNY81.84 million) from local sources for the subproject. As a result, its net fixed assets quickly increased to CNY136.85 million in 1999, or 8.4 times in 4 years. The low performance or nonperformance of virtually all the project components using ADB loan proceeds, i.e., the kiln and the molding equipment, valued at $8.12 million or CNY67 million, had a devastating impact on the PIAs financial performance. The returns on net fixed assets since 1999 have been negative, and the PIA is in no position to service its debt. The debt as a percentage of debt and equity has exceeded 100% since 2001 due to the diminishing and currently negative equity base, which means that the PIA, as a state-owned enterprise, is insolvent and is using debts from state-owned domestic banks to maintain its daily operations. F. Overall Assessment

11. Using ADBs five building blocks of evaluation, the subproject is assessed as partly relevant, inefficacious, inefficient, unlikely to be sustainable, with little institutional development and other impacts. Overall, the subproject is rated as unsuccessful.

The new factory management, however, is determined to make use of the equipment for producing a different type of porcelain product and the production is scheduled to start in mid-July of 2004.

38

Appendix 4

Table A4: Financial Performance of Tangshan No. 2 Porcelain Factory 19992003 (CNY million)
Year Ending December 31 Income Statements Sales Less: Cost of Sales Gross Profit Other Operating Income Less: Total Operating Expenses Selling Expenses Administrative Expenses Operating Income Less: Financial Expenses (income) Non-operating Income/(Expense) Other Adjustments Net Income Before Tax Net Income After Tax Cash Flow Statements Net Income After Tax Add: Non cash Charges Interest Expense Internal Cash Generation Borrowings Equity Contributions and Grants Received Proceeds from Investments Other Local Sources Total Sources of Funds Capital Expenditures Debt Service Other Payments Change in Working Capital Total Application of Funds Changes in Cash Cash Balance, Beginning of Year Cash Balance, End of Year 1999 3.91 3.98 (0.07) 7.74 2000 4.17 5.22 (1.05) 1.24 3.24 0.16 3.08 (3.05) 7.41 (2.17) 2001 0.79 1.25 (0.46) 1.31 2.61 0.04 2.57 (1.76) 5.11 (1.97) (8.84) (8.84) (8.84) 3.36 5.11 (0.37) 0.00 2002 4.56 5.50 (0.95) 0.63 3.30 0.10 3.20 (3.62) 5.03 (0.81) (9.46) (9.46) (9.46) 5.01 5.03 0.58 0.01 2003 1.35 1.32 0.04 (2.18) 3.77 0.19 3.58 (5.92) 5.14 0.28 (10.78) (10.78) (10.78) 5.11 5.14 (0.53)

(7.82) 6.15 0.03 0.16 (13.77) (12.63) (13.77) (12.63)

(13.77) (12.63) 6.23 5.30 6.15 7.01 (1.39) (0.32) 15.94 0.85

(10.63) 3.92 2.00 6.15 (3.61) 4.54 (0.62) 1.32 0.70

0.53 0.62 0.02

(0.37) 0.01

0.59 0.12 0.09 0.00

(0.53) 0.04 0.00

0.64 (0.12) 0.70 0.59

0.01 (0.38) 0.59 0.21

0.21 0.38 0.21 0.59

0.04 (0.57) 0.59 0.01

Appendix 4

39

Year Ending December 31 Balance Sheets Current Assets Cash and Deposits Accounts Receivable, net Inventories, net Other Current Assets Long-Term Investments Fixed Assets Less: Accumulated Depreciation Fixed Assets, net Construction in Progress Other Assets Total Assets

1999 14.96 0.70 0.88 12.31 1.07 10.61 150.83 13.98 136.85 8.67 21.76 192.85

2000 8.52 0.59 0.20 6.30 1.44 10.60 145.05 20.71 124.35 2.77 8.28 154.52 11.69 4.24 0.01 7.45 80.22 62.61 82.79 (20.19) 154.52 (2.33) (0.51) 56.16

2001 11.46 0.21 1.10 5.29 4.86 10.60 139.02 23.15 115.87 0.00 7.42 145.35 15.55 2.03 8.16 5.36 130.15 (0.36) 28.66 (29.02) 145.35 (1.46) (44.87) 100.28

2002 9.09 0.59 1.11 5.89 1.51 10.60 140.17 26.11 114.07 0.49 6.56 140.81 15.16 1.23 8.16 5.77 134.47 (8.82) 28.66 (37.49) 140.81 (3.15) 6.82 107.02

2003 36.71 0.02 1.13 5.21 30.35 10.60 102.62 20.41 82.21 0.31 5.70 135.53 16.34 1.28 8.16 6.89 138.79 (19.60) 28.66 (48.27) 135.53 (6.03) n.a 116.44

Current Liabilities 25.93 Accounts Payable 4.57 Short-Term Loans 7.42 Others 13.95 Long-Term Debt 128.12 Other Long Term -Liabilities Equity 38.80 Paid-in Capital 20.63 Surplus, Reserves, and Retained Earnings 18.16 Total Liabilities and Equity 192.85 Financial Indicators Return on Net Fixed Assets (%) a Debt-Service Coverage Ratio (times) b Debt/Debt Plus Equity (% of debt) c
a

(5.71) (0.23) 76.76

n.a. = not available. Net operating income after taxes as a percentage of average net fixed assets in operation. b Ratio of internal cash generation to annual debt service. c Ratio of long-term debt to long-term debt plus equity. Note: Accounts are for the consolidated operations of the company. Cash flow statements have been reconstructed from available accounts. Source: Tangshan No. 2 Porcelain Factory.

40

Appendix 5

SUBPROJECT 5: POLLUTION ABATEMENT AT TANGSHAN NO. 6 CERAMICS FACTORY A. Project Purpose and Scope at Appraisal

1. The factory was established in 1943, located in the main residential area of the city. It was operating three coal-fired tunnel kilns and five coal-fired dome kilns. The coal-fired tunnel kilns required about 15,900 tons of saggar,1 which reduced the output capacity by around 50% and absorbed extra heat. Coal consumption in the factory was 51 mega joules per kilogram (MJ/kg) of ceramics, compared with the average 11 MJ/kg of ceramics using a gas-fired system. 2. The Report and Recommendation of the President did not specify a clear purpose for the subproject. However, based on the purpose of the overall Project and the scope of the subproject, it may be inferred that the subproject had a dual purpose: (i) air pollution reduction, and (ii) improving the energy efficiency and quality of ceramic products. Under the subproject, all three coal-fired tunnel kilns were to be replaced by two 100-meter gas-fired tunnel kilns. Upon completion of the two new kilns, the next step was to demolish all five dome kilns and replace them with one new gas-fired tunnel kiln financed from the factorys own resources. Gas to the rehabilitated kilns would be supplied from the gasification plant built under Subproject 3. Major components included (i) provision of equipment and machinery, (ii) instrumentation and control, and (iii) staff training. B. Achievement of Outputs

3. The subproject was constructed largely as envisaged, including two highly automated tunnel kilns, one shuttle-type kiln, one gas-fired dryer, one set of electrostatic spraying equipment, and 16 pieces of high-pressure and one piece of mid-pressure molding equipment. The Operations Evaluation Mission (OEM) observed that the three kilns procured using Asian Development Bank (ADB) loan proceeds were in good condition, and the factory management indicated that they had performed very well since their commissioning in June 1996. However, the molding equipment from the same German supplier as in Subproject 4 was never properly constructed. Due to the sudden bankruptcy of the German supplier after the equipment had arrived at site, the supplier did not dispatch any staff to install, adjust, or test it or to train local staff as required by the contract.2 Strong efforts made by the Project Implementation Agency (PIA) to invite the suppliers former employees to complete the work with additional payment failed due to the very high prices demanded by the technicians. In the end, all other efforts also failed, and the equipment, at a cost of $6 million, was never functional. In addition, the spraying equipment, at a cost of about $500,000, could not reach the performance standards and was not operational as of the OEMs visit. As a result, the PIA had to invest additional resources to procure domestically produced molding and spraying equipment. The OEM observed the operation of the domestic equipment, particularly the spraying equipment, which is labor intensive and entails considerable health risks to the operators.

Saggar is a box made of fine clay in which ceramic pieces are placed and fired in the kiln. In a coal-fired kiln, saggar is needed to protect the ceramic ware from direct contact with soot, fly ash and other impurities. Coal consumption, due to saggar in kilns, is almost twice the normal energy consumption. According to the PIA and Executing Agency officials interviewed, the molding equipment was procured in advance in an effort by the PIA to avoid paying import tax which was to be introduced by the Government in the following year.

Appendix 5

41

C.

Cost and Scheduling

4. Subproject 5 was implemented together with Subproject 3, and the PIA provided the cost figures to the OEM for combined Subprojects 3 and 5. Therefore, the OEM could not independently confirm the project completion report (PCR) cost estimates for Subproject 5. Assuming the PCR estimates were correct, the actual cost of the subproject was $19.08 million, consisting of $13.18 million in foreign exchange cost and $5.90 million equivalent in local currency cost. This represents a significant 59% cost overrun. The cost overrun occurred in the foreign exchange cost, from the budgeted $6 million to the actual $13.18 million, while the actual local currency cost was within the budgeted $6 million. The main reason for the significant cost overrun was the higher cost of the molding equipment due to the limited number of venders that participated in the bid. The high cost coupled with nonperformance of the molding equipment has had a serious adverse impact on the performance of the subproject and the PIA. 5. Commissioning in June 1996 was well ahead of schedule by more than 2 years. This was partly attributed to the earlier than-usual procurement of key equipment including the kiln. D. Operational Performance

6. Despite the nonperformance of the molding and spraying equipment, unlike the kilns procured under Subproject 4, the three highly automated kilns perform very well and fully meet expectations. The products, which are low-end sanitary wares, are currently 100% for export. According to the factory manager, without the equipment, the factory would not have survived in todays fierce market competition. 7. In addition, with the gasification plant constructed under Subproject 3, which provided coal gas from 1996 to 2001, and coal gas supply from the city system afterwards, all eight coalfired dome kilns and three coal-fired tunnel kilns have been demolished. The average energy efficiency for the ceramics production process has improved almost five times, with energy intensity decreasing from 51 MJ/kg of ceramic product (when using coal firing) to 11 MJ/kg of ceramic product (current gas firing). Coal consumption at the plant has been eliminated. The environmental targets, as cited in Appendix 3 for Subproject 3, were fully achieved. E. Performance of the Operating Entity

8. Table A5 indicates that the total sales of the PIA increased from CNY18.15 million in 1995 to CNY27.64 million in 2003, averaging 5.4% per year. All the increases occurred after 1996 (when Subprojects 3 and 5 were commissioned), and the growth was subject to severe fluctuations. However, compared with other subproject enterprises, which have experienced mostly double-digit growth in sales, the average 5% growth was not enough to bring the PIA into positive territory, with a negative net income before tax for all years since 1998 with the exception of 2003, for which it had a CNY4.35 million surplus. As in the case for of the No. 2 Porcelain Factory, in 1995 the PIA had net fixed assets of only CNY27.22 million. Yet, it acquired a loan of $15.72 million (or CNY130.48 million) from ADB for the two subprojects. As a result, its net fixed assets quickly increased to CNY150.45 million in 2000, or 5.5 times in 5 years. The nonperformance of some project components, i.e., the molding and spraying equipment valued at $6.5 million or CNY54 million, and the underutilization of the gasification plant, at a cost of $3.55 million, have had a devastating impact on the PIAs financial performance. The returns on net fixed assets for most of the years have been negative, and the PIA is in no position to service its debt. In 2001, its debt as a percentage of debt plus equity was

42

Appendix 5

142%, which means the PIA, as a state-owned enterprise (SOE) was insolvent and using debts from state-owned domestic banks to maintain its daily operations. It should be said that the poor performance of the PIA in a fiercely competitive ceramics market cannot be entirely attributed to the investments made under the subproject. Other factors such as poor management and many other constraining factors facing the SOE also contribute to the results. F. Overall Assessment

9. Using ADBs five building blocks of evaluation, the subproject is assessed as partly relevant, inefficacious, inefficient, unlikely to be sustainable, with little institutional development and other impacts. Overall, the subproject is rated as unsuccessful.

Appendix 5

43

Table A5: Financial Performance of Tangshan No. 6 Ceramic Factory 19952003 (CNY million)
Year Ending December 31 Income Statements Sales Less: Cost of Sales Gross Profit Other Operating Income Less: Total Operating Expenses Selling Expenses Administrative Expenses Operating Income Less: Financial Expenses (income) Non-operating Income/(Expense) Other Adjustments Net Income Before Tax Net Income After Tax Cash Flow Statements Net Income After Tax Add: Noncash Charges Interest Expense Internal Cash Generation Borrowings Equity Contributions and Grants Received Proceeds from Investments Other Local Sources Total Sources of Funds Capital Expenditures Debt Service Other Payments Change in Working Capital Total Application of Funds Changes in Cash Cash Balance, Beginning of Year Cash Balance, End of Year 1995 18.15 9.64 8.51 8.31 1996 18.15 11.19 6.95 8.31 1997 21.65 11.98 9.67 6.88 1998 26.83 18.88 7.95 9.48 1999 26.38 29.74 (3.36) 11.92 2000 19.16 27.60 (8.44) 11.49 2001 7.00 10.74 (3.74) 11.05 2002a 2003a

14.22 10.57 3.64 4.33 2.06 2.27 (0.69) 0.02

0.20 0.00 0.00 0.00 0.20 0.20 0.20 3.67 3.87 6.44

(1.36) 1.84 0.25 3.10 0.15 0.15 0.15 8.42 1.84 10.42 10.41

2.79 1.54 0.03 0.05 1.33 1.33 1.33 0.63 1.54 3.50 0.90 0.00

(1.53) 1.49 0.03 0.18 (2.80) (2.80) (2.80) 3.23 1.49 1.92 5.33

(15.27) 13.02 0.01 25.28 (3.00) (3.00) (3.00) 2.48 13.02 12.50 60.00

(19.92) 10.31 (0.58) (46.80) (77.61) (77.61) (77.61) 9.67 10.31 (57.64) 62.90

(14.79) 6.97 0.61 (21.15) (21.15) (21.15) 5.07 6.97 (9.11) 66.17

27.64 17.59 10.05 0.00 5.64 2.96 2.68 4.41 0.05 0.00 4.35 2.92 2.92 0.00 0.05 2.97

(0.71) (0.71) (0.71) 0.02 (0.69)

14.23 24.53 96.50 14.26

19.55 40.37 41.07 12.39

4.40 16.55 1.54

0.10 7.34 3.02 0.00 0.00 5.18 8.20 (0.86) 1.52 0.66

1.19 73.69 60.42 5.46 7.59 73.47 0.22 0.66 0.88

59.83 65.10 109.06 8.01 (53.82) 63.25 1.84 0.88 2.72

(59.13) (2.07) 0.00 10.02 (10.97) (0.95) (1.12) 2.72 1.60

65.52 64.83 0.00 0.00 62.97 62.97 1.86 1.60 3.46

2.97 0.00 0.00 0.09 0.00 0.09 2.88 3.46 6.34

(86.23) (14.24) (14.05) 24.53 (0.00) 0.00 (0.00) 39.22 1.15 (0.00) 1.15 4.04 0.36 1.15 1.52

44

Appendix 5

Year Ending December 31 Balance Sheets Current Assets Cash and Deposits Accounts Receivable, net Inventories, net Other Current Assets Long-term Investments Fixed Assets Less: Accumulated Depreciation Fixed Assets, net Construction in Progress Other Assets Total Assets Current Liabilities Accounts Payable Short-Term Loans Others Long-Term Debt Other Long Term Liabilities Equity Paid-in Capital Surplus, Reserves, and Retained Earnings Total Liabilities and Equity Financial Indicators Return on Net Fixed Assets (%) b Debt-Service Coverage Ratio (times) c Debt/Debt Plus Equity (% of debt) d
a

1995

1996

1997

1998

1999

2000

2001

2002a

2003a

18.01 0.00 9.89 6.50 1.62 0.01 46.79 19.58 27.22 2.74 0.00 47.97 19.52 3.55 0.00 15.97 5.80 22.66 29.31 (6.66) 47.97 0.74 0.27 20.37

26.18 1.15 13.61 3.09 8.33 0.11 74.12 28.00 46.12 15.40 0.00 87.81 39.80 2.50 12.71 24.59 5.66 42.36 14.82 27.54 87.81 (3.70) 0.84 11.78

52.56 1.52 17.12 0.62 33.30 0.11 74.14 28.63 45.50 12.61 0.00 110.78 60.53 4.57 12.34 43.62 6.56 43.69 26.60 17.09 110.78 6.08 2.28 13.05

66.12 0.66 15.82 0.79 48.86 0.11 74.14 31.86 42.28 15.63 0.00 124.14 71.26 5.78 16.91 48.57 11.88 40.99 26.60 14.39 124.14 (3.48) n.a 22.48

73.40 0.88 13.38 3.77 55.37 0.11 134.03 34.34 99.69 16.16 0.00 189.35 78.28 5.54 17.11 55.63 71.88 39.19 27.10 12.09 189.35 (21.52) 2.29 64.72

39.72 2.72 13.60 9.79 13.62 0.11 194.46 44.00 150.45 64.79 0.00 255.07 98.88 19.38 25.16 54.34 134.78 21.40 86.93 (65.53) 255.07 (15.93) (7.19) 86.30

39.46 1.60 12.66 15.24 9.96 4.59 189.00 49.07 139.93 57.34 0.00 241.32 100.83 19.10 25.22 56.51 199.36 (58.87) 27.80 (86.67) 241.32 (10.18) (0.91) 141.90 n.a n.a n.a n.a n.a n.a

n.a. = not available. Tangshan No. 6 Ceramic Plant has been held in trust by the Hua Tian Cheng Ceramic Company Ltd since April 2002. The financial statements for 2002-2003 presented here are for the Hua Tian Cheng Ceramic Company, but reflect the performance of the subproject. b Net operating income after taxes as a percentage of average net fixed assets in operation. c Ratio of internal cash generation to annual debt service. d Ratio of long-term debt to long-term debt plus equity. Note: Accounts are for the consolidated operations of the company. Cash flow statements have been reconstructed from available accounts. Source: Tangshan No. 6 Ceramic Factory.

Appendix 6

45

SUBPROJECT 6: TANGSHAN DONGJIAO WASTEWATER TREATMENT PLANT A. Project Purpose and Scope at Appraisal

1. The Report and Recommendation of the President did not specify a clear purpose for the subproject. However, based on the purpose of the overall Project and the scope of the subproject, it may be inferred that the subproject had the purpose of improving Tangshans water quality. Under the subproject, the Dongjiao Wastewater Treatment Plant was to be established in the central district of Tangshan Municipality with a population of 343,000. Prior to the subproject, all sewerage and industrial effluent, amounting to about 214,000 cubic meters per day (m3/day) was discharged, mostly untreated, into the Dou River, causing contamination of the municipal water resources. 2. The design capacity of the plant was about 150,000 m3/day, of which industrial wastewater would amount to 100,000 m3/day and domestic sewerage to about 50,000 m3/day, with the main design parameters given in Table A6.1 The wastewater plant would handle wastewater from the southeastern part of the central district. Major components included (i) a secondary wastewater treatment plant with a capacity of about 150,000 m3/day, (ii) installation of one lift pump station outside the plant with a total capacity of about 50,000m3/day, (iii) installation of an approximately 5-kilometer (km) pipeline network system, and (iv) staff training. Table A6.1: Design Parameters of Dongjiao Wastewater Treatment Plant Water Quality Indicators Influent (mg/l) Effluent (mg/l)a Removal Ratio (%) 130 180 170 30 15 40 20 10 88 78 88 67

Pollutant Biochemical Oxygen Demand Chemical Oxygen Demand Suspended Solids Ammonia
mg/l = milligram per liter. a Effluent quality above the national standards.

B.

Achievement of Outputs

3. The Dongjiao Wastewater Treatment Plant was implemented as envisaged and commissioned in October 1997 ahead of schedule. Due to competition and other factors, there was a significant loan saving. With the Asian Development Banks (ADB) approval, a second plant of identical design, the Beijiao Wastewater Treatment Plant, was constructed and commissioned in November 2001. Both plants provide secondary treatment to influents using the oxidation ditch technology.1 Other outputs of the subproject included (i) installation of one lift pump station outside each plant, with a total capacity of about 50,000 m3/day; (ii) installation of an approximately 5-km pipeline network system; (iii) staff training; and (iv) installation of one effluent deep treatment/distribution pumping station at the Beijiao plant, with a capacity of 70,000 m3/day, and main pipes 1,449 meters (m) long of diameter 1,000 millimeters (mm) and 1,827 m long of diameter 1,200 mm. The Operations Evaluation Mission inspected the Beijiao
1

The Operations Evaluation Mission views the selection of the oxidation ditch technology as appropriate. Although it takes a larger area than some other treatment technologies, this technology has some crucial advantages: buffer to peak load, high-quality effluent, better treatment system stability, and easy to control/operate.

46

Appendix 6

plant and found that the engineering and civil works were generally done in accordance with international or national standards or with generally accepted practices. The quality of equipment and installation was satisfactory to excellent. C. Cost and Scheduling

4. The Project Implementation Agency (PIA) indicated that the project completion report cost estimates were correct. The actual cost of the subproject was $47.57 million, consisting of $23.28 in million foreign exchange cost and $24.29 million equivalent in local currency cost. This represents a 64% cost overrun compared with the appraisal estimate of $29 million. The main reason was that the subprojects scope was essentially doubled to construct two wastewater treatment plants of identical design instead of one. The cost increase was mainly in the local cost category, possibly reflecting larger-than-expected procurement from domestic goods and services and/or strong competition among international venders, which brought down prices. 5. The first wastewater treatment plant was commercially commissioned in October 1997, ahead of the original schedule by almost 2 years. However, the procurement and construction of the second plant took an additional 4 years. It was commissioned in October 2001. D. Operational Performance

6. Since their commission in October 1997 and October 2001, respectively, the two plants, with a combined capacity of 300,000 m3/day and both located in the eastern industrial section of the city, together with two existing smaller plants in the western residential areas of the city and Fengrun District, brought Tangshans municipal wastewater treatment ratio to about 65%, making it one of the best cities in terms of wastewater treatment in the Peoples Republic of China (PRC). As shown in Tables A6.2 and A6.3, the treated water exceeds the PRCs Class I effluent standard and has mostly met the design parameters (Table A6.1). Water quality in the citys main river, the Dou River, has improved markedly, and fish are once again visible.
Table A6.2: Key Operational Performance Indicators of Dongjiao Wastewater Treatment Planta
1999 Influent Effluent 849 67.3 46.3 8.1 2000 Influent Effluent 335 46.8 57.6 11.8 2001 Influent Effluent 300 58.7 68.7 9.7 2004 (up to May) Influent Effluent 386 121 52 10 National Effluent Standard 120 30

Item CODcr (mg/L) BOD5 (mg/L) SS (mg/L) pH

874

37.7 7.2

536

26.7 6.9

569

27.6 6.1

334 6-9

21 6-9

30 6-9

= not available, BOD = biological oxygen demand CODcr = chemical oxygen demand m3/day = cubic meter per day, mg/L = milligram per liter, pH = acidity value, SS = suspended solid. a Capacity =150,000 m3/day average flow rate = 90,000 m3/day. Source: Tangshan Wastewater Treatment Company.

Appendix 6

47

Table A6.3: Key Operational Performance Indicators of Beijiao Wastewater Treatment Planta
2001 Items CODcr (mg/L) BOD5 (mg/L) SS (mg/L) NH3 (mg/L) PH Influent 370.6 164.1 236.1 23.7 Effluent 58.1 16.3 27.6 2.3 7.2 Influent 383.9 161.6 189.5 47.2 2002 Effluent 31.8 5.8 17.5 4.4 6.9 2004 (up to May) Influent Effluent 575 275 327 8 47 15 6 8 National Discharge Standard 120 30 30 25 6-9

= not available, BOD = biological oxygen demand, CODcr = chemical oxygen demand, m3/day = cubic meter per day, mg/L = milligram per liter, pH = acidity value, SS = suspended solids, NH3 = ammonia. a Capacity =150,000 m3/day, average flow rate = 80,000 m3/day. Source: Tangshan Wastewater Treatment Company.

E.

Performance of the Operating Entity

7. Table A6.4 indicates that total sales increased from CNY27.12 million in 1998 to CNY60.32 million in 2003, averaging 17% growth per year. However, the fast-growing sales have not translated into higher profitability, with net income before tax actually decreasing from CNY0.75 million in 1998 to CNY0.31 million in 2003. More importantly, the operating income (from wastewater treatment after deducting total operating expenses) has been negative since 2000. In addition to rising operating expenses, two other factors contributed to this result. First, due to the rising water tariff (in which wastewater treatment charge forms a component) in Tangshan, many industrial users have increased their level of water reuse and recycle through increasing self-treatment. This has effectively reduced the demand for water and for municipal wastewater treatment services. The two plants built under the subproject are currently running at 57% of their capacities (combined average flow rate of 170,000 m3/day compared with the 300,000 m3/day capacity, Tables A6.2 and A6.3). Second, despite several increases of tariffs in recent years,2 the revenues generated are still below what is required to break even. The future prospect is less optimistic because the PIA is already charging a wastewater treatment fee for 100% of the wastewater generated but is able to collect and treat only about 65% of it.3 It appears at this particular time, the two plants financed by the subproject were over built in terms of their combined capacities relative to the actual demand that materialized. However, it is also true that if only one plant had been built as envisaged at appraisal, the capacity would have been short by at least 7% to meet the demand. The return on net fixed assets since 2000 has been negative. The debt-service coverage ratio, though not calculated due to lack of information, is understood to be well below 1, since the PIA was able to service only 25% of its debt to ADB (with the remaining portion serviced by the Government). The debt-equity ratio since 1998 has been below 65:35, meeting the ADB covenanted level of 80:20 or lower.

Since 1997, there have been three increases in water tariff. As a result, wastewater treatment charges for households, as a portion of the water tariffs, increased from CNY0.20/m3 in 1997 to CNY0.60/m3 in 2003. For 3 3 industries, the costs increased from CNY0.40/m to CNY0.85/m during the same period. The present average tariff for Tangshan city is CNY0.67/m3, the highest in the province. The fourth increase is planned for later in 2004, 3 which will bring the average to CNY0.85/m . Currently, the wastewater treatment tariff is charged and levied together with the water supply tariff, and the amount of wastewater generated is assumed to be 80% of the consumed water. However, the actual treatment rate is only 65% of the wastewater generated. In other words, 35% of the wastewater generated but not collected by the citys sewerage system is charged but not treated. The city is currently expanding its collection pipeline system to improve the collection rate.

48 F.

Appendix 6

Overall Assessment

8. Using ADBs five building blocks of evaluation, the subproject is assessed as highly relevant, efficacious, less efficient, likely to be sustainable, with substantial institutional development and other impacts. Overall, the subproject is rated as successful.

Appendix 6

49

Table A6.4: Financial Performance of Tangshan Wastewater Treatment Plant 19982003 (CNY million)
Year Ending December 31 Income Statements Sales Less: Cost of Sales Gross Profit Other Operating Income Less: Total Operating Expenses Selling Expenses Administrative Expenses Operating Income Less: Financial Expenses (income) Non-operating Income/(Expense) Net Income Before Tax Net Income After Tax Cash Flow Statements Net Income After Tax Add: Noncash Charges Interest Expense Internal Cash Generation Borrowings Equity Contributions and Grants Received Proceeds from Investments Other Local Sources Total Sources of Funds Capital Expenditures Debt Service Other Payments Change in Working Capital Total Application of Funds Changes in Cash Cash Balance, Beginning of Year Cash Balance, End of Year 1998 27.12 19.96 7.16 6.43 1999 28.45 20.33 8.12 7.56 2000 34.56 32.00 2.56 3.91 2001 43.82 40.75 3.07 1.84 6.67 6.67 (1.76) 0.01 2.01 0.25 0.17 0.17 13.10 0.07 13.33 24.25 2002 52.51 47.93 4.58 0.93 6.40 6.40 (0.89) 0.20 1.85 0.76 0.51 0.51 4.70 0.20 5.40 2003 60.32 53.76 6.56 0.11 8.12 8.12 (1.44) 0.11 1.86 0.31 0.20 0.20 14.20 0.11 14.52 0.00

0.73 (0.02) 0.75 0.50 0.50 6.32 (0.02) 6.80 70.20

0.56 0.01 (0.02) 0.52 0.35 0.35 6.66 0.01 7.02 1.48

(1.35) (0.00) 2.05 0.70 0.47 0.47 9.89 (0.00) 10.35 71.66

79.24 156.23 144.48 0.05 10.36 154.89 1.34 0.00 1.34

0.01 8.51

1.20 83.22

0.00 37.58 46.73 4.25 3.08

5.40 7.79 0.00

a

14.52 13.49 0.00

a

56.87 134.76 7.79 18.58 (58.86) (86.41) 5.79 2.72 1.34 4.05 66.93 16.29 4.05 20.34

54.06 (16.48) 20.34 3.86

7.79 (2.39) 3.86 1.47

13.49 1.02 1.47 2.50

50

Appendix 6

Year Ending December 31 Balance Sheets Current Assets Cash and Deposits Accounts Receivable, net Inventories, net Other Current Assets Long-Term Investments Fixed Assets Less: Accumulated Depreciation Fixed Assets, net Construction in Progress Other Assets Total Assets Current Liabilities Accounts Payable Short-Term Loans Others Long-Term Debt Equity Paid-in Capital Surplus, Reserves, and Retained Earnings Total Liabilities and Equity Financial Indicators Return on Net Fixed Assets (%)b Debt-Service Coverage Ratio (times)c Debt/Debt Plus Equity (% of debt)d
a

1998 14.33 1.34 5.25 0.20 7.54 0.16 144.06 6.32 137.74 0.18 0.08 152.49 2.61 0.19 0.00 2.42 70.20 79.69 72.49 7.20 152.49 0.53 135.98 46.83

1999

2000

2001

2002

2003 54.55 2.50 10.55 0.96 40.54 3.62 309.39 134.95 174.44 119.83 0.00 352.45 30.94 0.79 1.00 29.15 156.43 165.08 147.10 17.98 352.45 (0.80) 7.05 48.65

24.33 55.84 36.62 44.02 4.05 20.33 3.86 1.47 9.62 14.70 9.35 11.06 0.54 0.59 0.67 0.93 10.12 20.22 22.74 30.57 0.54 0.54 3.62 3.62 145.25 247.56 249.46 307.49 12.98 22.87 32.84 118.88 132.27 224.69 216.62 188.60 10.85 43.32 88.82 108.42 0.06 0.04 0.02 0.01 168.04 324.44 345.70 344.68 16.57 0.30 7.00 9.27 71.68 79.80 72.49 7.32 168.04 0.41 0.90 47.32 107.14 0.14 1.00 106.00 136.86 80.44 72.49 7.96 324.44 (0.76) 0.56 62.98 111.47 0.26 1.00 110.21 153.50 80.74 72.49 8.25 345.70 (0.80) 3.14 65.53 23.36 0.56 1.00 21.80 156.43 164.89 147.10 17.79 344.68 (0.44) 2.62 48.68

Interest payment of CNY2.06 million each year during 2002 and 2003 were not made by cash but through swapping tax rebates and government subsidies for partial debt serving. b Net operating income after taxes as a percentage of average net fixed assets in operation. c Ratio of internal cash generation to annual debt service. d Ratio of long-term debt to long-term debt plus equity. e Debt-service coverage ratios for 2002 and 2003 were calculated based on actual noncash debt service. Note: Accounts are for the consolidated operations of the company. Cash flow statements have been reconstructed from available accounts. Source: Tangshan Wastewater Treatment Plant.

Appendix 7

51

SUBPROJECT 7: COAL GASIFICATION PLANT UNDER THE NEW GAS COMPANY A. Project Purpose and Scope at Appraisal

1. The Report and Recommendation of the President (RRP) did not specify a clear purpose for the subproject. However, based on the purpose of the overall Project and the scope of the subproject, it may be inferred that the subproject had a dual purpose: (i) air pollution reduction, and (ii) ensuring the supply of low-cost, high-quality coke in order to improve the quality of steel products. Under the subproject, Chengde Municipality was to establish a coal gasification plant to supply gas to domestic households and to commercial and industrial customers. It was to have a design capacity of 720,000 cubic meters per day (m3/day), to be located 20 kilometers (km) from the city center in Luanhe Township, and to be operated by the Chengde Coal Gasification Company, Ltd. (a new gas company). Of the gas produced per day, plant consumption would amount to 250,000 m3, 140,000 m3 would be sold to domestic households (about 80% of total households in the municipality) 65,000 m3 to commercial users and public facilities, and 265,000 m3 to industrial users including the Chengde Iron and Steel Corporation. The plant was also to produce by-products for sale, such as coke, coal tar, benzol, and sulfur. Main components included (i) coal preparation plant, (ii) coke making plant, (iii) gas making plant, (iv) gas purification plant, (v) wastewater treatment plant, (vi) auxiliary plant and facilities, (vii) gas distribution network and storage facilities, and (viii) staff training. B. Achievement of Outputs

2. As the only subproject in Chengde, Subproject 7 was implemented largely as envisaged at appraisal, with minor delays. The main components included (i) a coal-preparation plant (a traditional design with conveyer belts and coal blending facilities, close-sealed for environmental protection); (ii) a coke production plant, consisting of two coke oven units with the capacity of 300,000 tons/year of dry coke each, which also generates 720,000 m3/day coking gas;1 (iii) a gas purification plant (to treat coking gas); (iv) a small industrial wastewater treatment facility; (v) a gas distribution network and storage facilities, including 85 km of gas pipelines (to link the plant to Chengde City), 17 pressure adjustment stations, and three gasholders with capacities of 50,000 m3, 50,000 m3, and 100,000 m3, respectively; and (vi) a waste gas recovery station, which mixes the coking gas with the blast furnace gas from the iron production process in Chengde Iron and Steel Plant, the Project Implementation Agency (PIA) for the subproject. The capacities of the coking plant, gasholders, and other equipment and facilities are generally the same as those envisaged during project design except for the length of the gas pipelines, which exceeded the original length by about 40 km. The quality of the construction was satisfactory to excellent and the facilities are in good condition. The Operations Evaluation Mission (OEM) site visit found that the coking cells were well sealed and there was no smoke visible during operation. The plant manager proudly informed OEM that the plant is one of the best in the Peoples Republic of China (PRC) with similar capacities. C. Cost and Scheduling

3. The PIA indicated that the project completion report cost estimates were correct. The actual cost of the subproject was $147.50 million, consisting of $55.00 million in foreign exchange cost and $92.50 million equivalent in local currency cost. The main reason for the
1

The RRP seems to suggest that that coke production and gas production are two different processes, with which the OEM disagrees. The RRP also suggests that coke is a by-product of coking gas, while the prevalent view at the plant is the opposite in terms of the market value of the products.

52

Appendix 7

cost overrun of 65.7%, compared with the appraisal estimate of $89.00 million, was the construction of a waste gas recovery station and longer pipelines. 4. There was a 6-month delay in commercial commission time, from December 1998 to June 1999, the main reason, according to the PIA, being that the original schedule was too tight to accommodate the Asian Development Banks (ADB) complex procurement procedures. D. Operational Performance

5. Since its commissioning in September 1999, the plant has reached or exceeded its design capacity for producing its key products, e.g., coke and coal gas.2 The production of coke has brought significant economic benefits to the Chengde Iron and Steel Company, the PIA, by ensuring a stable supply of high-quality and low-cost coke. However, the coal gas it produces, which was to be transmitted through the gas distribution network linking the gasification plant to the city located 20 km away, was consumed mostly on site by the Chengde Iron and Steel Company. Of the 720,000 m3 of gas produced each day, the coking plant consumes about 250,000 m3 as originally intended. However, for several reasons, the external demand has not materialized as envisaged at appraisal, and, as a result, the remaining gas is being consumed on site by the steel plant including supplying the companys resident apartment blocs. The gas supplying system, which was designed to serve at least 50,000 households in Chengde in order to break even financially, currently serves only 12,000 households. Chengde is one of the poorer municipalities in the province. A large number of households that have used liquefied petroleum gas (LPG) at home are not willing to pay CNY2500 as a connection fee, which is the equivalent of the LPG cost for 10 years for an average household. The commercial, public and industrial users have been using coal, oil, and LPG. During the last 10 years (until very recently), coal and oil prices were low. However, due to recent oil price hikes, some customers have started to switch to coal gas. Another reason is related to the difficulties in connecting old houses/apartment blocs to the distribution system, while the newly developed apartment buildings have mostly been connected. 6. The subproject intended to reduce coal consumption in Chengde City by 100,000 tons, total suspended particulates and ash discharges by 50,000 tons, and sulfur dioxide emissions by 4,340 tons annually. The PIA and the OEM estimated that, except coal consumption, these targets have generally been achieved, but most of the reduction was achieved near by the steel plant, not in Chengde city. In general, the subproject has drastically improved the air quality in and around the steel plant, where many steel workers and their families live, but the contribution to the citys air quality has been much lower than intended. E. Performance of the Operating Entity

7. The Chengde Iron and Steel Group executed the subproject. A new company, the Chengde Coal Gasification Company, Ltd., was formed under the Group to operate the plant. Table A7 indicates that the total sales of the Chengde Coal Gasification Company increased from CNY395.34 million in 2000 to CNY782.76 million in 2003, averaging 25.6% growth per
2

In all Asian Development Bank project documentation including the RRP, the plant is referred to as a coal gasification plant, and the coal gas is referred to as the primary product, while coke, the other main product, is referred to as a by-product. This was probably caused by Managements desire to emphasize the Projects environmental benefits while downplaying the economic benefits. This has clearly contrasted with the impression of the PIA which always refers to the plant as a coking plant. The 2003 sales figures also reflect this. Coke accounted for 64.2% of the total sales of the plant, while coal gas accounted for 30.6%. The plant also produces by-products including coal tar, benzol, and sulfur.

Appendix 7

53

year. Industrial coke accounts for more than 65% of the total sales, coal gas for about 25%, while other by-products including coal tar and sulfur account for the rest. Of all the six PIAs, the Chengde Coal Gasification Company is probably the most financially sound, in part due to the strong demand by both international and domestic markets for its main product, industrial coke. The return on net fixed assets for 2002 was about 6.2% but increased to 37.6% in 2003 due to strong demand and higher prices for coke. With a debt-service coverage ratio well above 1.3, the company has no problem in servicing its debt. However, its debt-equity ratio, at 83:17 in 2003, is above the ADB covenanted level of 80:20. F. Overall Assessment

8. Using ADBs five building blocks of evaluation, the subproject is assessed as highly relevant, efficacious, efficient, likely to be sustainable, with moderate institutional and developmental impacts. Overall, the subproject is rated as successful.

54

Appendix 7

Table A7: Financial Performance of Chengde Coal Gas Company 20002003

(CNY million) Year Ending December 31 Income Statements Sales Less: Cost of Sales Gross Profit Other Operating Income Less: Total Operating Expenses Selling Expenses Administrative Expenses Operating Income Less: Financial Expenses (income) Non-operating Income/(Expense) Other Adjustments Net Income Before Tax Net Income After Tax Cash Flow Statements Net Income After Tax Add: Noncash Charges Interest Expense Internal Cash Generation Borrowings Equity Contributions and Grants Received Proceeds from Investments Other local Sources Total Sources of Funds Capital Expenditures Debt Service Other Payments Change in Working Capital Total Application of Funds Changes in Cash Cash Balance, Beginning of Year Cash Balance, End of Year 2000 2001 2002 2003

395.34 398.07 (2.73) 8.96

477.14 444.66 32.48 12.17

532.58 782.76 475.40 506.56 57.18 276.20 (1.33) (11.48) 4.86 6.90

(11.69) 36.17 (0.16) (15.36) (63.37) (63.37)

20.31 23.56 (0.18) (0.68) (4.11) (4.11)

50.99 48.71

257.82 26.38

2.28 2.28

231.44 231.44

(63.37) 20.18 36.17 (7.02) 1.96

(4.11) 43.24 23.56 62.70 14.03

2.28 142.44 48.71 193.43

231.44 53.61 26.38 311.43

9.11 4.05 139.71 49.31 (188.72) 0.30 3.74 0.99 4.73

0.80 77.52 73.87 60.39 (60.03) 74.24 3.28 4.73 8.01

193.43

311.43 7.85 26.38 16.42 260.51 311.15 0.28 0.99 1.26

48.71 129.44 22.30 200.45 (7.02) 8.01 0.99

Appendix 7

55

Year Ending December 31 Balance Sheets Current Assets Cash and Deposits Accounts Receivable, net Inventories, net Other Current Assets Long-Term Investments Fixed Assets Less: Accumulated Depreciation Fixed Assets, net Construction in Progress Other Assets Total Assets Current Liabilities Accounts Payable Short-Term Loans Others Long-Term Debt Other Long-Term Liabilities Equity Paid-in Capital Surplus, Reserves, and Retained Earnings Total Liabilities and Equity Financial Indicators Return on Net Fixed Assets (%)a Debt-Service Coverage Ratio (times)b Debt/Debt Plus Equity (% of debt)c
a b

2000

2001

2002

2003

107.17 4.73 0.00 39.17 63.27 0.00 805.60 20.51 785.09 316.56 28.17 1,237.00 628.49 87.86 0.00 540.63 521.26

53.54 8.01 0.00 22.58 22.95 0.00 1,007.04 63.75 943.29 190.07 27.10 1,214.00

41.83 0.99 0.26 9.26 31.32 918.02 206.19 711.83 172.94 16.99 943.59

34.09 1.26 4.69 1.15 26.98 919.36 259.79 659.56 174.90 22.88 891.43

603.31 576.33 307.80 154.19 31.53 17.63 0.00 0.00 0.00 449.12 544.80 290.17 526.75 500.52 485.44 0.00 87.24 83.94 (133.26) 98.18 123.20 123.20 123.20 123.20 (35.96) (39.26) (256.46) (25.02) 1,237.00 1,214.00 943.59 891.43 (1.49) (0.14) 85.66 2.35 1.04 86.26 6.16 3.97 136.28 37.60 11.81 83.18

Net operating income after taxes as a percentage of average net fixed assets in operation. Ratio of internal cash generation to annual debt service. c Ratio of long-term debt to long-term debt plus equity. Note: Accounts are for the consolidated operations of the company. Cash flow statements have been reconstructed from available accounts. Source: Chengde Coal Gas Company.

56

Appendix 8

PROJECT COSTS ($ million) Appraisal Estimate FX LC Total Actual Costs FX LC Total

Component A. By Subproject

Subproject 1: Gas Supply and Distribution Network System Land Site Preparation Equipment and Machinery Civil Works Engineering and Domestic Design Training Consultants Base Cost Physical Contingency Subtotal Price Contingency IDC (including Financial Charges) Total Subproject 2: District Heating System Land Site Preparation Equipment and Machinery Civil Works Engineering and Domestic Design Training Consultants Base Cost Physical Contingency Subtotal Price Contingency IDC (including Financial Charges) Total Subproject 3: Coal Gasification Plants Land Site Preparation Equipment and Machinery Civil Works Engineering and Domestic Design Training Consultants Base Cost Physical Contingency Subtotal Price Contingency IDC (including Financial Charges) Total 0.00 0.00 10.28 0.00 0.00 0.20 0.10 10.58 1.06 11.64 1.14 1.22 14.00 0.00 0.00 1.03 0.67 1.14 0.02 0.00 2.86 0.28 3.14 0.76 0.10 4.00 0.00 0.00 11.31 0.67 1.14 0.22 0.10 13.44 1.34 14.78 1.90 1.32 18.00 0.00 0.00 2.35 0.00 0.00 0.00 0.09 2.44 0.00 2.44 0.00 0.10 2.54 0.00 0.00 0.92 0.00 0.00 0.00 0.00 0.92 0.00 0.92 0.00 0.09 1.01 0.00 0.00 3.27 0.00 0.00 0.00 0.09 3.36 0.00 3.36 0.00 0.19 3.55 0.00 0.00 17.66 0.00 0.00 0.17 0.50 18.33 1.83 20.16 2.17 3.67 26.00 0.00 0.26 15.61 1.90 1.07 0.06 0.00 18.90 1.89 20.79 6.26 3.95 31.00 0.00 0.26 33.27 1.90 1.07 0.23 0.50 37.23 3.72 40.95 8.43 7.62 57.00 0.00 0.00 14.12 0.00 0.00 0.17 0.23 14.52 0.00 14.52 2.42 0.00 16.94 0.81 0.68 5.85 9.69 5.68 0.06 0.00 22.77 0.00 22.77 0.44 0.00 23.21 0.81 0.68 19.97 9.69 5.68 0.23 0.23 37.29 0.00 37.29 2.86 0.00 40.15 0.00 0.00 4.15 0.00 0.00 0.15 0.08 4.38 0.44 4.82 0.57 0.61 6.00 0.00 0.00 2.49 1.17 0.28 0.03 0.00 3.97 0.40 4.37 0.62 0.01 5.00 0.00 0.00 6.64 1.17 0.28 0.18 0.08 8.35 0.84 9.19 1.19 0.62 11.00 0.00 0.00 5.15 0.00 0.00 0.07 0.04 5.26 0.00 5.26 0.00 0.61 5.87 0.54 0.00 0.95 7.34 0.26 0.05 0.02 9.16 0.00 9.16 0.00 1.00 10.16 0.54 0.00 6.10 7.34 0.26 0.12 0.06 14.42 0.00 14.42 0.00 1.61 16.03

Appendix 8

57

Component

Appraisal Estimate FX LC Total

Actual Costs ($ million) FX LC Total

Subproject 4: Pollution Abatement at No. 2 Porcelain Factory Land Equipment and Machinery Civil Works Engineering and Domestic Design Training Consultants Base Cost Physical Contingency Subtotal Price Contingency IDC (including Financial Charges) Total 0.00 8.36 0.00 0.00 0.10 0.09 8.55 0.86 9.41 1.07 1.52 12.00 0.35 4.40 0.58 0.39 0.02 0.00 5.74 0.57 6.31 1.59 1.10 9.00 0.35 12.76 0.58 0.39 0.12 0.09 14.29 1.43 15.72 2.66 2.62 21.00 0.00 5.85 0.00 0.00 0.06 0.03 5.94 0.00 5.94 0.00 2.18 8.12 0.43 0.00 2.50 5.56 0.27 0.00 8.76 0.00 8.76 0.00 1.10 9.86 0.43 5.85 2.50 5.56 0.33 0.03 14.70 0.00 14.70 0.00 3.28 17.98

Subproject 5: Pollution Abatement at No. 6 Ceramic Factory Land Equipment and Machinery Civil Works Engineering and Domestic Design Training Consultants Base Cost Physical Contingency Subtotal Price Contingency IDC (including Financial Charges) Total 0.00 4.54 0.00 0.00 0.10 0.03 4.67 0.47 5.14 0.43 0.43 6.00 0.00 2.00 1.50 0.60 0.02 0.00 4.12 0.41 4.53 0.70 0.77 6.00 0.00 6.54 1.50 0.60 0.12 0.03 8.79 0.88 9.67 1.13 1.20 12.00 0.00 11.96 0.00 0.00 0.07 0.03 12.06 0.00 12.06 0.00 1.12 13.18 0.00 0.00 5.15 0.00 0.00 0.00 5.15 0.00 5.15 0.00 0.75 5.90 0.00 11.96 5.15 0.00 0.07 0.03 17.21 0.00 17.21 0.00 1.87 19.08

Subproject 6: Tangshan Dongjiao Wastewater Treatment Plant Land Equipment and Machinery Civil Works Engineering and Domestic Design Training Consultants Base Cost Physical Contingency Subtotal Price Contingency IDC (including Financial Charges) Total 0.00 15.65 0.10 0.00 0.11 0.27 16.13 0.81 16.94 1.72 2.34 21.00 0.11 4.41 0.41 0.85 0.07 0.00 5.85 0.59 6.44 1.33 0.23 8.00 0.11 20.06 0.51 0.85 0.18 0.27 21.98 1.40 23.38 3.05 2.57 29.00 0.00 19.61 0.00 0.00 0.14 0.17 19.92 0.00 19.92 0.00 3.36 23.28 1.82 0.64 1.15 18.62 0.92 0.00 23.15 0.00 23.15 0.00 1.14 24.29 1.82 20.25 1.15 18.62 1.06 0.17 43.07 0.00 43.07 0.00 4.50 47.57

58

Appendix 8

Component Chengde Coal Gasification Plant

Appraisal Costs FX LC Total

Actual Costs FX LC Total

Subproject 7: Chengde Coal Gasification Plant Land Equipment and Machinery Civil Works Engineering and Domestic Design Training Consultants Base Cost Physical Contingency Subtotal Price Contingency IDC (including Financial Charges) Total 0.00 39.56 0.00 0.00 0.20 0.60 40.36 4.04 44.40 3.30 7.30 55.00 1.00 14.33 5.17 3.16 0.10 0.00 23.76 2.34 26.10 5.16 2.74 34.00 1.00 53.89 5.17 3.16 0.3 0.6 64.12 6.38 70.50 8.46 10.04 89.00 0.00 47.49 0.00 0.00 0.05 0.16 47.70 0.00 47.70 0.00 7.30 55.00 6.63 5.12 74.33 2.44 0.41 1.08 90.01 0.00 90.01 0.00 2.49 92.50 6.63 52.61 74.33 2.44 0.46 1.24 137.71 0.00 137.71 0.00 9.79 147.50

B. Total Project Costs Land Site Preparation Equipment and Machinery Civil Works Engineering and Domestic Design Training Consultants Base Cost Physical Contingency Subtotal Price Contingency IDC (including Financial Charges) Total 0.00 0.00 100.20 0.10 0.00 1.03 1.67 103.00 9.51 112.51 10.40 17.09 140.00 1.46 0.26 44.27 11.40 7.49 0.32 0.00 65.20 6.48 71.68 16.42 8.90 97.00 1.46 0.26 144.47 11.50 7.49 1.35 1.67 168.20 15.99 184.19 26.82 25.99 237.00 0.00 0.00 106.53 0.00 0.00 0.56 0.75 107.84 0.00 107.84 2.42 14.67 124.93 10.23 0.68 13.48 100.16 32.56 1.71 1.10 159.92 0.00 159.92 0.44 6.57 166.93 10.23 0.68 120.01 100.16 32.56 2.27 1.85 267.76 0.00 267.76 2.86 21.24 291.86

FX = foreign currency, IDC = interest during construction, LC = local currency.

Appendix 9

59

ASSUMPTIONS FOR FINANCIAL ANALYSIS A. General

1. Recalculation of the financial internal rate of return (FIRR) was carried out on an incremental and after-tax basis in 2003 constant prices. Investment costs and benefits are expressed in real terms. The economic life of the project facilities is assumed to be the same as those in the Report and Recommendation of the President (RRP) and the project completion report (PCR), namely 20 years for No. 2 Tangshan Porcelain Factory (Subproject 4), No. 6 Tangshan Ceramic Factory (Subprojects 3 and 5), Chengde Coal Gasification Company (Subproject 7), and Tangshan Wastewater Treatment Plant (Subproject 6); and 25 years for Tangshan Gasification Company (Subproject 1) and Tangshan Heat and Power Company (Subproject 2), with no salvage value. The exchange rate used in FIRR recalculation was CNY8.3 per US dollar. B. Capital Investment

2. The investment costs are based on the actual capital investment costs recorded at the time of loan closing and excluded interest during construction. The capital investment cost for Subproject 5 at Tangshan No. 2 Porcelain Factory excluded domestic financing that occurred after the time of loan closing but was previously envisioned in the project cost estimate in the RRP.1 C. Project Output and Benefits

3. The incremental project outputs are based mainly on sales of products and services from the project facilities, with the output prices responding to market demand. 4. The benefit from environmental improvement in financial terms is realized in the reduction of environmental mitigation costs at the subproject enterprises concerned. The benefits from energy displacement and efficiency improvement are reflected in the reduction of production cost and the enhancement of production volume. 5. In the case of Subproject 5 at Tangshan No. 2 Porcelain Factory, as the factory is planning to use the Asian Development Bank (ADB) financed facilities to produce fine bone china from the second half of 2004, instead of steatite china, which was originally designed for the project facilities at appraisal, the project output of the ADB-financed facilities reflects the actual production of steatite china before 2004 and the projected production of fine bone china from 2004 onward. 6. Benefits from the old production facilities were adjusted to the actual product/service prices. Output volumes from the old facilities after the project commissioning year are assumed to remain the same level in the year just before project commissioning. However, in the case of Subprojects 3 and 5 at Tangshan No. 6 Ceramic Plant, by the time the ADB-financed facilities were commissioned, the old production facilities had either reached or surpassed their service lives. In addition, the items produced by the old facilities had little market demand at that time.
1

Strictly speaking, the costs using domestic financing after the loan was closed should also be included as project costs since the components financed were envisaged as a part of the Project. However, the factory has been physically split into two portions, and the portion that received the domestic financing belongs to a joint venture company. The costs provided to the Operations Evaluation Mission by the factory did not include that portion.

60

Appendix 9

Keeping the operation of those old facilities would not only have incurred heavy financial losses, but would also severely violate the local environmental protection regulations. It is therefore assumed that, without the project, Tangshan No. 6 Ceramic Plant would have been forced to cease utilization of those old production facilities in 1996, and to retain all related employees due to local human resources policies. As such, without the project, benefits from the old facilities at Tangshan No. 6 Ceramic Plant are assumed to be zero from 1996 onward, while the operation cost related to the old facilities for the same period is assumed to be the management and administrative expenses at the1995 level. D. Operation Costs

7. The incremental operation costs were based on actual costs incurred during the operation of project facilities, while depreciation and financial charges were excluded. Certain adjustments were made to reflect the assumed increases in production volume and actual input prices. 8. Operation costs of the old production facilities include the additional replacement costs of worn-out equipment and facilities wherever applicable. Certain adjustments were made to reflect actual input prices. The operation costs of old facilities at Tangshan No. 6 Ceramic Plant from 1996 onwards are assumed to be the management and administrative expenses at the 1995 level. E. Projection

9. As in the RRP and the PCR, the projections for each subproject were made for a period of either 20 or 25 years, wherever applicable. Projections on production volume, sales volume, sales price, and production cost for the ADB-financed facilities were based on the forecast figures provided by each subproject enterprise, with the market trend taken into consideration. F. Weighted Average Cost of Capital (WACC)

10. The WACC was recalculated in real terms, and based on the shares of financing sources as well as the average nominal costs with respect to the ADB loan, domestic loans, and equity participation. The domestic inflation rate is averaged at 2%. G. Sensitivity Analysis

11. Sensitivity analysis was carried out to analyze the impacts of changes in output prices, raw material prices and overall operation cost, on the sustainability of the Project.

Appendix 9

61

Table A9.1: FIRR for Subproject 1- Tangshan Gas (CNY million) Year Ending Dec 31 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Capital Cost 11.48 6.37 33.08 17.73 21.37 4.72 8.43 17.43 1.60 Incremental Revenue 4.66 5.72 19.03 31.74 26.03 36.28 52.31 53.36 64.11 75.74 89.23 91.96 98.12 106.34 119.34 128.95 128.95 128.95 128.95 128.95 128.95 128.95 128.95 128.95 128.95 128.95 128.95 128.95 128.95 128.95 Incremental Operating Cost 5.03 4.47 18.89 23.90 29.29 44.04 49.35 62.41 77.69 85.22 88.01 83.93 80.67 78.38 76.18 73.15 64.15 55.15 46.15 37.15 28.15 19.15 10.15 1.15 (7.85) (16.85) (25.85) (34.85) (43.85) (52.85) FIRR WACC Net Cash After Tax (11.48) (6.90) (32.02) (18.23) (15.20) (8.85) (17.39) (16.21) (12.42) (15.71) (11.99) (1.75) 4.94 11.12 17.97 27.87 36.12 42.15 48.18 54.21 60.24 66.27 72.30 78.33 84.36 90.39 96.42 102.45 108.48 114.51 120.54 11.5% 6.6%

Items Base case Gas sales price +10% Gas purchase cost +10% Total operation cost +10% Combination of: Gas sales price +10%, while total operation cost +10%

FIRR 11.5% 12.6% 9.9% 9.8%

11.1%

62

Appendix 9

Table A9.2: FIRR for Subproject 2 - Tangshan Heating Power (CNY million) Year Ending Dec 31 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Incremental Operating Cost

Capital Cost 3.31 8.78 43.50 71.08 32.81 62.20 46.91 38.54 12.24 24.20

Incremental Revenue

Net Cash After Tax (3.31) (8.78) (43.50) (71.08) (26.72) (48.83) (31.37) (19.30) 6.27 18.49 (8.43) 22.06 32.63 32.63 32.63 32.63 32.63 32.63 32.63 32.63 32.63 32.63 32.63 32.63 32.63 32.63 32.63 32.63 32.63 32.63 6.2% 5.1%

16.88 33.22 40.79 45.06 60.41 69.73 65.54 82.14 102.67 102.67 102.67 102.67 102.67 102.67 102.67 102.67 102.67 102.67 102.67 102.67 102.67 102.67 102.67 102.67 102.67 102.67

10.23 18.21 22.28 20.90 36.83 45.87 45.87 52.53 56.61 56.61 56.61 56.61 56.61 56.61 56.61 56.61 56.61 56.61 56.61 56.61 56.61 56.61 56.61 56.61 56.61 56.61 FIRR WACC

Items Base case Heat sales price +10% Heat purchase cost +10% Total operation cost +10% Combination of: Heat sales price +10%, while total operation cost +10%

FIRR 6.2% 7.6% 5.8% 5.3%

6.8%

Appendix 9

63

Table A9.3: FIRR for Subprojects 3&5: Tangshan No. 6 Ceramic (CNY million) Year Ending Dec 31 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Capital Cost 93.62 40.30 17.15 0.33 10.95 0.10 0.10 0.60 0.40 Incremental Revenue Incremental Operating Cost Net Cash After Tax (93.62) (35.01) (11.15) 3.95 (7.38) (16.73) (5.28) 3.12 7.85 3.96 6.43 6.43 6.43 6.43 6.43 10.98 10.98 10.98 10.98 10.98 15.98

20.65 21.91 27.28 27.22 19.79 7.41 14.68 28.00 46.44 69.48 69.48 69.48 69.48 69.48 76.39 76.39 76.39 76.39 76.39 84.00

14.97 15.51 22.50 23.15 36.06 12.46 10.68 18.94 41.23 61.76 61.76 61.76 61.76 61.76 61.76 61.76 61.76 61.76 61.76 61.76

FIRR WACC

-2.4% 4.6%

Items Base case Product price +10% Raw material price +10% Heat purchase cost +10% Salaries and welfare expenses -10% Total operation cost +10% Combination of: Product price +10%, while heat purchase cost +10% Product price +10%, while total operation cost +10%

FIRR -2.4% 1.7% -3.5% -2.6% -1.8% -6.8%

1.6% -0.1%

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Appendix 9

Table A9.4: FIRR for Subproject 4 -Tangshan No. 2 Porcelain (CNY million) Year Ending Dec 31 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Incremental Operating Cost

Capital Cost 0.06 28.89 25.96 48.00 8.48 2.66 2.00

Incremental Revenue

Net Cash After Tax (0.06) (28.89) (25.96) (48.00) (8.48) (4.17) 1.34 (0.83) (0.99) (0.25) 1.92 1.70 2.01 2.01 2.01 2.01 2.01 2.01 2.01 2.01 2.01 2.01 2.01 2.01 2.01 -8.5% 4.9%

3.98 4.23 0.79 4.59 1.35 11.05 21.31 25.07 25.07 25.07 25.07 25.07 25.07 25.07 25.07 25.07 25.07 25.07 25.07 25.07

5.42 0.81 1.61 5.49 1.58 8.93 19.21 22.60 22.60 22.60 22.60 22.60 22.60 22.60 22.60 22.60 22.60 22.60 22.60 22.60 FIRR WACC

Items Base case Raw material price -10% Ceramic product price +10% Utility cost +10% Manufacturing cost -10% Total operation cost -10% Combination of: Product price +10%, while utilities cost +10% Product price +10%, while total operation cost +10%

FIRR -8.5% -7.2% -4.0% -6.8% -4.2%

-4.7% -8.2%

Appendix 9

65

Table A9.5: FIRR for Subproject 6 - Tangshan Wastewater (CNY million) Year Ending Dec 31 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Capital Cost 11.69 19.64 80.56 39.38 9.44 57.21 102.97 35.71 0.00 17.40 18.39 Incremental Revenue Incremental Operating Cost Net Cash After Tax (11.69) (19.64) (80.56) (39.38) (0.57) (47.78) (90.30) (24.94) 21.50 8.93 11.76 34.24 34.24 34.24 34.24 33.96 33.96 33.96 33.96 33.96 33.73 33.73 33.73 33.73

15.80 17.37 18.08 22.59 36.13 48.77 61.83 73.17 73.17 73.17 73.17 73.17 73.17 73.17 73.17 73.17 73.17 73.17 73.17 73.17

6.40 7.37 4.81 11.07 11.63 16.64 23.57 28.42 28.42 28.42 28.42 28.84 28.84 28.84 28.84 28.84 29.18 29.18 29.18 29.18

FIRR WACC

3.6% 4.3%

Items Base case Wastewater treatment tarrif +10% Electricity cost +10% Total operation cost +10% Combination of: Tariff +10%, while total operation cost +10%

FIRR 3.6% 4.5% 3.6% 3.3%

4.2%

66

Appendix 9

Table A9.6: FIRR for Subproject 7 - Chengde Coal Gas (CNY million) Year Ending Dec 31 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Incremental Operating Cost

Capital Cost 22.62 2.97 82.67 194.12 283.12 376.68 125.42 65.85

Incremental Revenue

Net Cash After Tax (22.62) (2.97) (82.67) (194.12) (283.12) (376.68) (60.73) (4.39) 90.53 216.28 207.20 207.36 207.51 207.67 207.82 207.96 208.11 208.24 208.38 208.51 208.64 208.77 208.90 209.04 209.17 209.30

460.60 480.39 538.56 820.57 807.06 807.30 807.53 807.77 808.00 808.23 808.47 808.70 808.93 809.17 809.40 809.63 809.87 810.10 810.33 810.57

391.17 414.54 428.33 521.00 521.13 521.13 521.13 521.13 521.13 521.17 521.17 521.20 521.24 521.27 521.31 521.34 521.38 521.41 521.45 521.49

FIRR WACC

11.7% 5.9%

Items Base case Coal gas price +10% Coke price -10% Coal price +10% Operation cost +10% Growth of households and commercial users -20% Combination of: 1. Coal gas unchanged, coke price -10%, production cost +10%, and growth of households and commercial users -20% 2. Coal gas price +10%, coke price -10%, operation cost +10%, and growth of household and commercial users -20%

FIRR 11.7% 12.2% 10.3% 10.7% 10.3% 11.7%

8.6%

9.3%

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67

Table A9.7: Overall FIRR for Tangshan-Chengde Environment Improvement Project (CNY million) Year Ending Dec 31 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Capital Cost 11.48 44.05 187.00 290.74 391.10 338.90 518.13 294.84 141.79 12.85 17.40 42.99 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Incremental Revenue 0.00 4.66 5.72 39.67 53.65 85.99 118.07 595.79 609.61 718.47 1,044.16 1,081.16 1,145.36 1,176.05 1,184.51 1,197.74 1,207.58 1,214.73 1,214.96 1,215.19 1,215.43 1,215.66 1,223.50 1,139.73 1,139.97 1,067.03 1,042.18 231.62 231.62 231.62 231.62 Incremental Operating Cost 0.00 5.03 4.47 33.86 39.41 68.42 98.19 504.49 523.00 570.66 689.24 728.73 766.98 771.19 768.90 766.70 764.12 755.12 746.15 737.19 728.22 719.60 710.64 639.92 630.95 592.81 561.24 30.76 21.76 12.76 3.76 FIRR WACC Net Cash After Tax (11.48) (44.58) (185.93) (285.94) (378.94) (323.78) (502.23) (214.00) (67.16) 104.72 239.31 214.65 276.74 293.94 300.95 311.00 319.11 329.84 336.00 342.16 348.32 354.26 365.42 355.60 361.76 334.19 338.34 135.07 141.10 147.13 153.16 8.5% 5.4%

68

Appendix 10

ASSUMPTIONS FOR ECONOMIC ANALYSIS A. General

1. Recalculation of the economic internal rate of return (EIRR) was carried out on an incremental basis using a domestic currency world price numeraire, i.e., bringing all costs and benefits into the world price equivalent at the border using CNY. Incremental costs and benefits are determined by comparing situations with and without the Project for each subproject. The economic life of the project facilities remained the same as those in the Report and Recommendation of the President and the project completion report, namely 20 years for No.2 Tangshan Porcelain Factory (Subproject 4), No. 6 Tangshan Ceramic Factory (Subprojects 3 and 5), Chengde Coal Gasification Company (Subproject 7), and Tangshan Wastewater Treatment Plant (Subproject 6), and 25 years for Tangshan Gasification Company (Subproject 1) and Tangshan Heat and Power Company (Subproject 2), with no salvage value. All prices were expressed in 2003 constant prices. 2. Environmental benefits in the form of health impacts such as reduction of respiratory diseases of the employees of the subproject enterprises and the citizens in the two cities were not quantified due to the following reasons even though they may be significant: First, estimation of the health impact of air pollution requires modeling or coefficients relating damage of air pollution to human health to actual pollution or dose levels. Presently such methodologies have not been fully developed. Second, in the context of the Peoples Republic of China (PRC), the data required, particularly dose-response data, are not available and, as a result, they would have to be borrowed from elsewhere such as the United States. Third, there is the issue of attribution to what extent the observed improvement in health, if any, can be attributed to the Project. Other factors that need to be taken into account include how to evaluate sickness or human lives. Based on these considerations, the environmental benefits were not quantified but have been taken into account in the overall project assessment. B. Converting Financial Prices to Economic Prices

3. Economic values of capital costs were derived by converting actual financial capital cost components with applicable conversion factors. Taxes, duties, and interest during construction were excluded. Imported equipment was valued at international prices (cost, insurance, and freight), while local equipment was valued by applying a conversion factor of 1.1 to the respective financial costs to adjust them to border prices, assuming that domestic prices for equivalent items are lower than world prices due to fierce price undercutting among domestic manufacturers. The conversion factor for civil works was 1.1, while the conversion factor for the rest of capital cost components was 0.926. 4. Economic costs for inputs to all subprojects were derived by converting their financial costs with applicable conversion factors. A conversion factor of 0.926 was applied to all inputs and outputs except for coal, heat, coal gas, and electricity. The conversion factor for electricity was assumed to be 0.9. As coal is an exportable input, its economic price was valued at its free on board (FOB) price minus local transport and handling costs, adjusted to the source of supply. Coal gas and heat were considered to be nontradable goods, so the economic values were determined based on the replacement of fuels that would have been otherwise consumed in the absence of the subprojects. Specifically, coal gas was valued based on the border price of liquefied petroleum gas (LPG) or heavy oil, whichever was applicable, while heat was valued based on the border price of coal. Other project outputs such as porcelain/ceramic products and those by-products such as coke, coal tar, sulfur, benzol, and heavy oil, were all valued at their

Appendix 10

69

border price with adjustments for local transportation and handling costs depending on whether they were exportable output or import substitute or both. C. Assumptions Used to Estimate Economic Benefits and Costs

5. Economic benefits of subprojects included incremental economic benefits/costs to the society at large. Environmental benefits accrued to the society at large (e.g., improved health) were not quantified and, thus, not included in the analysis. The benefits from energy displacement and efficiency improvement were reflected in the reduced production cost and/or enhanced production volume. Other subproject-specific assumptions are given below. 1. Subproject 1: Tangshan Gas Supply and Distribution Network

6. The economic benefits of coal gas included coal displacement adjusted for energy efficiency improvement. For domestic coal gas users, the economic price of coal gas was valued at the cost of LPG. For industrial users, the economic price of coal gas was valued at the cost of coal. 7. It is assumed that the thermal efficiency of coal gas is three times that of coal burning using domestic stoves, and two times that of coal burning using industrial furnaces. Savings from local delivery cost of coal to domestic coal users was calculated on the basis that the incity delivery distance was 5 kilometers (km) at CNY12/km/ton. It was then estimated that, after the subproject reaches full capacity in 2009, about 378,122 tons of coal will be replaced by coal gas per year, of which direct coal displacement will account for 113,550 tons and thermal efficiency improvement for 264,572 tons. 2. Subproject 2: Tangshan District Heating System

8. Economic benefits of heat comprise those associated with coal displacement adjusted for thermal efficiency improvement. The economic price of heat was valued at the economic price of an equivalent amount of coal. It is assumed that the thermal efficiency of heat production is 1.9 times that of individual boilers. Savings in terms of local delivery cost to coal users was taken into consideration, calculated on the basis that the in-city delivery distance was 5 km at CNY12/km/ton. It was then estimated that, after the subproject reaches its full capacity in 2006, 321,846 tons of coal will be replaced by heat from district heating systems per year, of which direct coal displacement will account for 169,392 tons and thermal efficiency improvement for 152,453 tons. 3. Subproject 4: Pollution Abatement at Tangshan No. 2 Porcelain Factory

9. Benefits from energy displacement and efficiency improvement were reflected implicitly in reduced production cost and enhanced production output, both in volume and in quality. 10. The porcelain products were treated as an import substitute, as the factory sold all its project products in the domestic market, even though the original intention was to export them. It assumed that, without the subproject, the products would have to be imported. The average economic price of porcelain products was estimated at CNY4.1 per unit, which was calculated on basis of the border price of porcelain products of the same kind with adjustments for local transportation and handling costs.

70

Appendix 10

4.

Subprojects 3 and 5: Pollution Abatement at Tangshan No. 6 Ceramic Factory

11. Benefits from energy displacement adjusted for efficiency improvement were reflected implicitly in reduced production cost and enhanced production, both in volume and in quality. 12. The ceramic products were treated as both an import substitute and an exportable output. The subproject factory exported 42% of the products from project facilities to the overseas market. It was assumed that, without the subproject, the 58% of the products sold in the domestic market would have to be imported. The average economic price of the ceramic products was CNY79.18 per unit, which was calculated on the basis of the border price of ceramic products of the same kind, with adjustments for local transportation and handling costs. 5. Subproject 6: Tangshan Wastewater Treatment Plant

13. The service of wastewater treatment is nontradable. The economic benefit of wastewater treatment was in principle valued at a price which customers were willing to pay in order to enjoy the amenity and health benefits of cleaner rivers and water bodies. Due to a lack of empirical survey data in the PRC, after consultation with the domestic consultant wastewater treatment specialist, a conversion factor of 1.5 was believed to be a reasonable approximation to convert the current financial tariff of wastewater treatment to the economic benefit of wastewater treatment. This implies a 50% consumer surplus. Further, the economic price of recycled water, which can be used for most industrial purposes but not for drinking and bathing, was also valued at the price that customers were willing to pay, which was estimated as CNY0.44 per cubic meter, by the Operations Evaluation Mission based on information provided by the subproject enterprise. 6. Subproject 7: Chengde Coal Gasification Plant

14. For domestic coal gas users, the economic price of coal gas was valued at the cost of LPG, while for industrial users, the economic price of coal gas was valued at the cost of the border price of heavy oil with adjustments for local transport and handling costs. Savings in terms of cost of local coal delivery was calculated by assuming that the local delivery cost was CNY12/ km/ton and that the average in-city delivery distance was 5 km. Economic prices for byproducts such as coke, coal tar, sulfur, and benzol, were valued at their border prices, with adjustments for local transportation and handling costs. It was estimated that, as the subproject had already reached full capacity, 7,302 tons of coal and 152,806 tons of heavy oil were saved on an annual basis, being replaced by coal gas. D. Projections

15. The projections for each subproject were made for a period of either 20 or 25 years, whichever was applicable. Projections on production volume, sales volume, sales price, and production cost for the Asian Development Bank-financed facilities were based on forecast figures provided by each subproject enterprise, with the market trend taken into consideration.

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71

Table A10.1: EIRR for Subproject 1 - Tangshan Gas (CNY million) Year Ending Dec 31 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Capital Cost 12.08 6.70 34.81 18.66 22.49 4.97 8.87 18.35 1.68 Incremental Benefit 0.00 1.19 4.83 16.16 31.45 35.24 37.05 49.55 54.73 78.15 91.75 105.31 111.56 118.76 128.17 143.95 155.62 155.62 155.62 155.62 155.62 155.62 155.62 155.62 155.62 155.62 155.62 155.62 155.62 155.62 155.62 EIRR Incremental Operating Cost 0.00 5.21 4.63 19.56 24.75 30.34 45.61 51.11 64.63 80.46 88.26 91.15 86.92 83.54 81.17 78.89 75.76 66.44 57.12 47.80 38.48 29.15 19.83 10.51 1.19 (8.13) (17.45) (26.77) (36.09) (45.41) (54.73) Net Benefit (12.08) (10.73) (34.61) (22.07) (15.79) (0.06) (17.43) (19.90) (11.59) (2.31) 3.49 14.17 24.64 35.22 46.99 65.06 79.86 89.18 98.50 107.82 117.14 126.46 135.78 145.10 154.42 163.74 173.06 182.39 191.71 201.03 210.35 16.8%

Items Base case Gas sales price +10% Gas purchase cost +10% Total operation cost +10% Combination of: Gas sales price +10%, while total operation cost +10%

EIRR 16.8% 15.7% 15.4% 15.3%

14.1%

72

Appendix 10

Table A10.2: EIRR for Subproject 2- Tangshan Heating Power (CNY million) Year Ending Dec 31 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Incremental Operating Cost

Capital Cost 3.40 9.04 44.79 73.19 33.79 64.04 48.30 39.68 12.33 24.20

Incremental Benefit

Net Benefit (3.40) (9.04) (44.79) (73.19) (40.92) (54.32) (19.24) (13.36) 15.02 45.14 18.00 54.20 75.03 75.03 75.03 75.03 75.03 75.03 75.03 75.03 75.03 75.03 75.03 75.03 75.03 75.03 75.03 75.03 75.03 75.03 13.4%

1.08 24.35 46.97 46.60 56.93 81.99 79.05 96.40 120.50 120.50 120.50 120.50 120.50 120.50 120.50 120.50 120.50 120.50 120.50 120.50 120.50 120.50 120.50 120.50 120.50 120.50 EIRR

8.21 14.63 17.90 20.28 29.59 36.85 36.85 42.20 45.47 45.47 45.47 45.47 45.47 45.47 45.47 45.47 45.47 45.47 45.47 45.47 45.47 45.47 45.47 45.47 45.47 45.47

Items Base case Heat sales price +10% Heat purchase cost +10% Total operation cost +10% Combination of: Heat sales price +10%, while total operation cost +10%

EIRR 13.4% 14.1% 13.2% 12.9%

13.7%

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73

Table A10.3: EIRR for Subproject No. 3&5: Tangshan No. 6 Ceramic (CNY million) Year Ending Dec 31 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Capital Cost 96.31 41.12 17.31 0.00 10.82 0.10 0.10 0.60 0.40 Incremental Benefit Incremental Operating Cost Net Benefit (96.31) (33.29) (8.62) 7.98 (3.51) (12.59) (4.06) 4.82 12.03 10.76 16.82 16.82 16.82 16.82 16.82 24.18 24.18 24.18 24.18 24.18 32.29

21.61 22.96 28.69 28.61 20.70 7.51 15.25 29.45 49.10 73.66 73.66 73.66 73.66 73.66 81.02 81.02 81.02 81.02 81.02 89.12

13.78 14.27 20.71 21.31 33.18 11.47 9.83 17.43 37.94 56.84 56.84 56.84 56.84 56.84 56.84 56.84 56.84 56.84 56.84 56.84

EIRR

4.2%

Items Base case Product price +10% Raw material price +10% Heat purchase cost +10% Salaries and welfare expenses -10% Total operation cost +10% Combination of: Product price +10%, while heat purchase cost +10% Product price +10%, while total operation cost +10%

EIRR 4.2% 7.5% 3.6% 4.1% 3.7% 2.0%

7.4% 6.1%

74

Appendix 10

Table A10.4: EIRR for Subproject 4 -Tangshan No. 2 Porcelain (CNY million) Year Ending Dec 31 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Incremental Operating Cost

Capital Cost 0.06 28.46 25.57 47.23 8.34 2.61 1.97

Incremental Benefit

Net Benefit (0.06) (28.46) (25.57) (47.23) (8.34) (3.65) 1.61 (0.71) (0.48) (0.10) 2.94 3.77 4.44 4.44 4.44 4.44 4.44 4.44 4.44 4.44 4.44 4.44 4.44 4.44 -4.2%

4.10 4.36 0.82 4.72 1.39 11.39 21.96 25.83 25.83 25.83 25.83 25.83 25.83 25.83 25.83 25.83 25.83 25.83 25.83 25.83 EIRR

5.13 0.77 1.52 5.20 1.49 8.45 18.18 21.39 21.39 21.39 21.39 21.39 21.39 21.39 21.39 21.39 21.39 21.39 21.39 21.39

Items Base case Raw material price -10% Ceramic product price +10% Utility cost +10% Manufacturing cost -10% Total operation cost -10% Combination of: Product price +10%, while utilities cost +10% Product price +10%, while total operation cost +10%

EIRR -4.2% -3.6% -1.4% -4.9% -3.4% -1.8%

-1.8% -3.8%

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75

Table A10.5: EIRR for Subproject 6 - Tangshan Wastewater (CNY million) Year Ending Dec 31 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Capital Cost 14.22 19.54 73.83 37.04 8.88 55.63 103.33 33.72 17.40 18.39 Incremental Benefit Incremental Operating Cost Net Benefit (14.22) (19.54) (73.83) (37.04) 8.52 (36.81) (80.94) (10.72) 42.77 39.40 48.50 76.43 76.43 76.43 76.43 76.03 76.03 76.03 76.03 76.03 75.69 75.69 75.69 75.69

23.70 26.06 27.11 33.88 54.20 73.16 89.78 103.82 103.82 103.82 103.82 103.82 103.82 103.82 103.82 103.82 103.82 103.82 103.82 103.82

6.29 7.24 4.73 10.88 11.43 16.36 22.89 27.39 27.39 27.39 27.39 27.79 27.79 27.79 27.79 27.79 28.13 28.13 28.13 28.13

EIRR

13.5%

Items Base case Wastewater treatment tariffs +10% Electricity cost +10% Total operation cost +10% Combination of: Tariff +10%, while total operation cost +10%

EIRR 13.5% 14.4% 13.4% 13.3%

14.2%

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Appendix 10

Table A10.6: EIRR for Subproject 7 - Chengde Coal Gas (CNY million) Year Ending Dec 31 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Incremental Operating Cost

Capital Cost 23.61 3.10 86.28 202.57 295.46 393.10 130.88 68.72

Incremental Benefit

Net Benefit (23.61) (3.10) (86.28) (202.57) (295.46) (393.10) (63.85) 55.94 176.95 350.08 325.99 352.37 350.39 348.62 346.84 345.03 343.25 341.44 339.62 337.81 335.99 334.18 332.36 330.55 328.73 326.91 17.6%

521.63 606.42 674.74 955.57 931.64 958.01 956.03 954.26 952.48 950.71 948.93 947.16 945.39 943.61 941.84 940.06 938.29 936.51 934.74 932.97 EIRR

454.61 481.77 497.79 605.49 605.64 605.64 605.64 605.64 605.64 605.68 605.68 605.72 605.76 605.80 605.84 605.89 605.93 605.97 606.01 606.05

Items Base case Coal gas price +10% Coke price -10% Coal price +10% Operation cost +10% Growth of households and commercial users -20% Combination of: 1. Coal gas unchanged, coke price -10%, production cost +10%, and growth of households and commercial users -20% 2. Coal gas price +10%, coke price -10%, operation cost +10%, and growth of household and commercial users -20%

EIRR 17.6% 18.0% 16.0% 16.5% 16.0% 16.7%

14.3%

14.9%

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77

Table A10.7: Overall EIRR for Tangshan-Chengde Environment Improvement Project (CNY million) Year Ending Dec 31 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 Capital Cost 12.08 48.00 191.27 290.24 399.83 351.44 535.08 302.93 143.90 12.93 17.40 42.99 Incremental Benefit 0.00 1.19 4.83 37.76 54.42 88.71 120.17 670.32 749.96 884.00 1,233.31 1,266.26 1,365.40 1,398.60 1,406.23 1,420.24 1,430.13 1,435.72 1,433.95 1,432.17 1,430.40 1,428.63 1,434.95 1,344.06 1,342.28 1,236.69 1,209.08 276.12 276.12 276.12 276.12 EIRR Incremental Operating Cost 0.00 5.21 4.63 33.34 39.03 65.55 93.92 562.30 590.55 634.30 765.87 802.92 837.17 840.27 837.90 835.62 832.93 823.61 814.33 805.05 795.77 786.83 777.55 711.44 702.16 664.75 634.08 18.70 9.38 0.06 (9.26) Net Benefit (12.08) (52.03) (191.06) (285.82) (384.44) (328.28) (508.83) (194.91) 15.51 236.77 450.04 420.36 528.23 558.32 568.33 584.62 597.20 612.11 619.61 627.12 634.63 641.79 657.40 632.62 640.12 571.94 575.01 257.41 266.73 276.05 285.37 14.7%

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Appendix 11

ENVIRONMENTAL INDICATORS FOR TANGSHAN Table A11.1: Tangshan Air Quality Monitoring Results (2003) (mg/m3) National Class II Standard 0.10 0.06 0.08

Pollutant TSP SO2 NO2

1990 0.690 0.104 0.045

Annual Average 2002 0.157 0.091 0.047

2003 0.127 0.091 0.039

mg/m3 = milligram per cubic meter, NO2 = nitrogen dioxide, SO2 = sulfur dioxide, TSP = total suspended particulates. Source: Tangshan Environment Protection Bureau.

Table A11.2: Real Time Air Quality Monitoring Results for 8 June 2004 (Downtown) PM10 (mg/m3) 0.157 0.165 0.181 0.163 0.126 0.200 0.178 0.125 0.098 0.102 0.066 0.062 0.073 0.095 0.038 0.060 0.012 0.054 SO2 (mg/m3) 0.010 0.010 0.011 0.011 0.009 0.006 0.006 0.012 0.009 0.024 0.048 0.061 0.059 0.055 0.052 0.055 0.057 0.046 NOx (mg/m3) 0.068 0.053 0.044 0.037 0.033 0.040 0.039 0.059 0.057 0.067 0.050 0.050 0.048 0.043 0.045 0.047 0.059 0.059 NO2 (mg/m3) 0.053 0.042 0.034 0.028 0.024 0.030 0.028 0.042 0.039 0.045 0.035 0.036 0.036 0.034 0.036 0.040 0.051 0.052 NO (mg/m3) 0.014 0.011 0.010 0.009 0.009 0.011 0.011 0.017 0.017 0.022 0.015 0.014 0.012 0.010 0.009 0.007 0.007 0.007

Day/Time 00:00 01:00 02:00 03:00 04:00 05:00 06:00 07:00 08:00 09:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00

mg/m3 = milligram per cubic meter, NOx =nitrogen oxide, NO2 = nitrogen dioxide, PM = particulate matter , SO2 = sulfur dioxide. Source: Tangshan Environment Protection Bureau.

MANAGEMENT RESPONSE ON THE PROJECT PERFORMANCE AUDIT REPORT ON THE TANGSHAN AND CHENGDE ENVIRONMENTAL IMPROVEMENT PROJECT IN PEOPLES REPUBLIC OF CHINA (Loan 1270-PRC)

On 7 February 2005, the Director General, Operations Evaluation Department, received the following response from the Managing Director General on behalf of Management:

1. Management and staff have reviewed the Project Performance Audit Report (PPAR) for Loan 1270-PRC: Tangshan and Chengde Environmental Improvement Project (the Project), and would like to provide the following comments. 2. The Project included seven components of varying scope and thereby different costs and benefits. The Project Completion Report (PCR) circulated on 9 October 2002, rated the project as successful.1 OED reviewed the PCR and validated the methodology used, and the rating. The PPAR has now adopted a different methodology and rated the Project as partly successful. 3. Due to the multi-component feature of the Project, the PPAR has identified the limitation of applying the current Guidelines for the Preparation of Project Performance Audit Report to determine the overall project rating, and explained the new approach that it used. However, the new approach does not provide a direct link between the ratings of individual components and that of the overall project. In our view, the overall Project rating in the PPAR is conservative, because it does not take into account the overall weighted average (OWA), or the overall EIRR and FIRR. 4. A lack of clarity regarding the methodology for determining overall rating in multi-component projects will lead to inconsistencies in project evaluation. We suggest that OED augment the guidelines for evaluating multi-component projects. 5. We have taken note of the key lessons and follow-up actions stated in the PPAR and will take them into account for the design of similar future ADB projects, as outlined below: (i) The low rating of some subprojects highlights the importance of (a) more rigorous analysis of assumptions in the case of linked subprojects, and (b) technical recommendations of consultants being verified by in-house experts, and where in-house capacity is lacking, avoidance of investments in such subprojects. The PPAR supports the current operational strategy in PRC that focuses on achieving public goods through public utilities and staying away from supporting industrial projects. Similarly,

(ii)

"With the achievement of the main objective of air improvement despite the about 1.3% increase in the city population in the last 10 years and an annual economic growth rate of about 10% per annum, the Project is rated as successful."

integrating subprojects in selected cities will enhance the impact of environmental improvement projects. (iii) Choice of appropriate technologies is considered important, particularly because of the rapid technological developments in environmental engineering and cleaner production. Further, sustainability of subprojects and environmental benefits must be given equal emphasis. Staff review of project implementation has been strengthened to help identify potential contractual problems and seek alternate solutions for successfully commissioning equipment.

(iv)

OPERATIONS EVALUATION DEPARTMENT COMMENT ON MANAGEMENT RESPONSE TO THE PROJECT PERFORMANCE AUDIT REPORT ON THE TANGSHAN AND CHENGDE ENVIRONMENTAL IMPROVEMENT PROJECT IN PEOPLES REPUBLIC OF CHINA (Loan 1270-PRC)

On 10 February 2005, the Director General, Operations Evaluation Department (OED), issued the following comment on the Management response:

1. With reference to your memo dated 4 February 2005 regarding Management Response to OED Report: Loan 1270-PRC: Tangshan and Chengde Environmental ProjectProject Performance Audit Report (PPAR), OED has taken note of your observation on the overall project rating and the need for consideration of an appropriate approach to aggregating ratings of multisubproject projects. 2. OED is currently revising the Guidelines for the Preparation of Project Performance Audit Report, which will consider the complexities associated with evaluating multi-subproject projects like this one.