Document of THE WORLD BANK

FOR OFFICIAL USE ONLY

Public Disclosure Authorized Report No: 60014-CN

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED LOAN

Public Disclosure Authorized IN THE AMOUNT US$100 MILLION

TO THE

PEOPLE‟S REPUBLIC OF CHINA

FOR AN

URUMQI DISTRICT HEATING PROJECT

April 21, 2011

Public Disclosure Authorized

China and Mongolia Sustainable Development Unit Sustainable Development Department East Asia and Pacific Region

Public Disclosure Authorized This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

CURRENCY EQUIVALENTS

(Exchange Rate Effective July 1, 2010)

Currency Unit = RMB (Chinese Yuan Renminbi) RMB6.70 = US$1.00 US$0.149 = RMB1.00

FISCAL YEAR

January 1 – December 31

ABBREVIATIONS AND ACRONYMS

CDM Clean Development Mechanism NA Not Applicable CHP Combined Heat and Power Plant ORAF Operational Risk Assessment Framework DA Designated Account PAD Project Appraisal Document DH District Heating PDO Project Development Objective EA Environmental Assessment PIU Project Implementation Unit EHS WB/IFC Environmental Health and PLG Project Leading Group Safety EHS Environmental Health and Safety PM Procurement Manual EIA Environmental Impact Assessment PMO Project Management Office EIRR Economic Internal Rate of Return RMB Renminbi (Chinese Yuan) EMP Environmental Management Plan RPF Resettlement Policy Framework ESP Electrostatic Precipitators SBD Standard Bidding Documents FM Financial Management SCADA Supervisory Control and Data Acquisition FMM Financial Management Manual SHN Shayibake Heating Network FRR Financial Rates of Return SLA Subsidiary Loan Agreement FYP Five-Year Plan SOE State-Owned Enterprise GEF Global Environment Facility SW Staff-Week HOB Heat Only Boilers TA Technical Assistance HRBEE GEF-financed China Heat Reform TOR Terms of Reference and Building Energy Efficiency Project IBRD International Bank for TSP Total Suspended Particulates Reconstruction and Development ICB International Competitive Bidding TTL Task Team Leader IDA International Development Agency UDHC Urumqi District Heating Company IFC International Finance Corporation UHN Shuimogou Heating Network (WB Group) IFRs Interim Financial Reports UITCPO Urumqi International Technical Cooperation Project Office

L Low UMG Urumqi Municipal Government LIBOR London Interbank Offered Rate UUCC Urumqi Urban Construction Commission M&E Monitoring and Evaluation WACC Weighted Average Cost of Capital MBD Model Bidding Documents WB World Bank MI Medium-Impact WBPG World Bank Project Group MFB Municipal Finance Bureau XRAO Xinjiang Uyghur Autonomous Region Audit Office MOF Ministry of Finance XRFB Xinjiang Uyghur Autonomous (RFB) Region Finance Bureau

Regional Vice President: James W. Adams, EAPVP Country Director: Klaus Rohland, EACCF Sector Director: John Roome, EASSD Sector Managers: Ede Jorge Ijjasz-Vasquez, EASCS Vijay Jagannathan, EASIN Task Team Leader: Gailius J. Draugelis, EASCS

CHINA Urumqi District Heating Project

CONTENTS

I. STRATEGIC CONTEXT ...... 1 A. Country Context ...... 1 B. Sectoral and Institutional Context ...... 2 C. Higher Level Objectives to which the Project Contributes ...... 4 II. PROJECT DEVELOPMENT OBJECTIVES ...... 4 A. PDO ...... 4 B. Project Beneficiaries ...... 5 C. PDO Level Results Indicators ...... 5 III. PROJECT DESCRIPTION ...... 5 A. Project components ...... 5 B. Project Financing ...... 7 1. Lending Instrument ...... 7 2. Project Cost and Financing ...... 7 C. Lessons Learned and Reflected in the Project Design...... 7 IV. IMPLEMENTATION...... 8 A. Institutional and Implementation Arrangements ...... 8 B. Results Monitoring and Evaluation ...... 8 C. Sustainability ...... 9 V. KEY RISKS AND MITIGATION MEASURES ...... 9 VI. APPRAISAL SUMMARY ...... 10 A. Economic and Financial Analysis ...... 10 B. Technical ...... 12 C. Financial Management ...... 13 D. Procurement ...... 13 E. Social (including safeguards) ...... 13 F. Environment (including safeguards) ...... 14 G. Other Safeguards Policies triggered (if required)...... 15 Annex 1: Results Framework and Monitoring ...... 16 Annex 2: Detailed Project Description ...... 19 Annex 3: Implementation Arrangements ...... 27 Annex 4 Operational Risk Assessment Framework (ORAF) ...... 39

Annex 5: Implementation Support Plan ...... 42 Annex 6: Team Composition ...... 45 Annex 7: Economic and Financial Analysis ...... 46 Annex 8: Map ...... 57

CHINA

URUMQI DISTRICT HEATING PROJECT

PROJECT APPRAISAL DOCUMENT

EAST ASIA AND PACIFIC

EASCS

Date: April 21, 2011 Sector(s): District heating and energy Country Director: Klaus Rohland efficiency services (100%) Sector Director: John Roome Theme(s): Pollution management and Sector Managers: Ede Jorge Ijjasz-Vasquez; environmental health (34%); Other urban Vijay Jagannathan development (33%); Climate change (33%) Team Leader: Gailius J. Draugelis EA Category: A Project ID: P120664 Lending Instrument: Specific Investment Loan

Project Financing Data:

Proposed terms: Variable spread loan has a final maturity of thirty years including a grace period of five years. [X] Loan [ ] Credit [ ] Grant [ ] Guarantee [ ] Other:

Source Total Amount (US$ M) Total Project Cost: 343.20 Cofinancing: 0 Borrower: 243.20 Total Bank Financing: 100.00

IBRD 100.00 IDA New Recommitted

Borrower: Ministry of Finance (MOF) / PR China and Urumqi Municipality Responsible Agency: Urumqi International Technical Cooperation Project Office Urumqi Construction Commission No. 29, Xinxing Road, Urumqi, PR China Contact Person: Mr. Qiao Yu, Director Telephone / Fax No.: +86-991-4617-327 Email: [email protected]

Estimated Disbursements (Bank FY/US$ m) FY 2012 2013 2014 2015 2016 Annual 30 30 20 15 5 Cumulative 30 60 80 95 100

Project Implementation Period: February 1, 2011 – June 30, 2015 Expected effectiveness date: October 19, 2011 Expected closing date: December 31, 2015

○ Yes ● No Does the project depart from the CAS in content or other significant respects?

If yes, please explain:

Does the project require any exceptions from Bank policies? ● Yes ○ No Have these been approved/endorsed (as appropriate by Bank ● Yes ○ No (Not applicable) management? Is approval for any policy exception sought from the Board? ○ Yes ● No If yes, please explain: An increase in retroactive financing from 20% to 30% of the Loan amount has been approved by management.

● Yes ○ No Does the project meet the Regional criteria for readiness for implementation? If no, please explain:

Project Development Objective: The proposed project development objective (PDO) is to connect consumers in selected districts of Urumqi to district heating services with improved energy efficiency and environmental performance.

Project description

Component A. Shuimogou District Urumqi CHP Plant District Heating Network Construction of district heating networks with associated ancillary equipment, substations (including building level substations), control, monitoring and dispatch systems and control centers, meters, and maintenance vehicles, and associated civil and installation works and recovery of public infrastructure damaged by installation in Urumqi‟s Shuimogou District.

Component B: Shayibake District CHP Heating Network Construction of district heating networks with associated ancillary equipment, substations (including building level substations), control, monitoring and dispatch systems and control centers, meters, and maintenance vehicles, and associated civil and installation works and recovery of public infrastructure damaged by installation in Urumqi‟s Shayibake District and Tianshan District.

Component C: Institutional Development and Project Management. Strengthening the capacity of UDHC and Urumqi in Project management, monitoring, and evaluation; and supporting UDHC‟s and Urumqi‟s institutional development through the provision of technical assistance, training, study tours, and operational support.

Safeguard policies triggered?

Environmental Assessment (OP/BP 4.01) ● Yes ○ No Natural Habitats (OP/BP 4.04) ○ Yes ● No Forests (OP/BP 4.36) ○ Yes ● No Pest Management (OP 4.09) ○ Yes ● No Physical Cultural Resources (OP/BP 4.11) ○ Yes ● No Indigenous Peoples (OP/BP 4.10) ○ Yes ● No Involuntary Resettlement (OP/BP 4.12) ● Yes ○ No Safety of Dams (OP/BP 4.37) ○ Yes ● No Projects on International Waters (OP/BP 7.50) ○ Yes ● No Projects in Disputed Areas (OP/BP 7.60) ○ Yes ● No

Conditions and Legal Covenants: Financing Agreement Description of Condition/Covenant Date Due Reference Loan Agreement (LA), The Subsidiary Loan Agreement has Effectiveness condition 4.01 and 4.02 been executed between Urumqi and UDHC and duly authorized or ratified by Urumqi and UDHC.

Project Agreement (PA), Except as the Bank shall otherwise agree, During implementation Annex A to Schedule, UDHC shall maintain for each of its Paragraph 11 fiscal years after its fiscal year ending on December 2011, a ratio of operating expenses to operating revenues not higher than 90%. Project Agreement (PA), Except as the Bank shall otherwise agree, During implementation Annex A to Schedule, UDHC shall maintain a ratio of current Paragraph 12 assets to current liabilities of not less than 1.3. Project Agreement (PA), If any review shows that UDHC would During implementation Annex A to Schedule, not meet the financial covenant Paragraphs 11(c) and 12 requirements for UDHC‟s fiscal years (c) covered by such review, UDHC shall promptly take all necessary measures (including, without limitation, adjustments of the structure or levels of its tariffs in order to meet such requirements. Project Agreement (PA), For the purposes of carrying out the During implementation Schedule, Paragraph 2 Project, the Project Implementing Entity (a) shall relend the proceeds of the Loan to UDHC under a Subsidiary Loan Agreement, with terms and conditions acceptable to the Bank. Project Agreement (PA), UDHC and UMG shall undertake to: (a) During implementation Annex A to Schedule, carry out the Project with due diligence Paragraph 5 and 6. and efficiency and in accordance with appropriate management, financial, engineering and public utility practices and social and environmental standards acceptable to the Bank, including the Anti-corruption Guidelines applicable to the recipient of the Loan proceeds other than the Borrower, and provide, promptly as needed, the funds, facilities and other resources required for the purpose; and (b) without limitation on the foregoing, take all measures necessary to ensure that the Project shall be implemented in accordance with the Environmental Management Plan and the Resettlement Policy Framework.

I. STRATEGIC CONTEXT

A. Country Context

1. Economic development of central and western regions in China is a high priority of the central government. A policy-induced investment boom tilted toward western and central China is a part of the central government‟s efforts to spread benefits of economic growth into its less developed regions. Due to its deep integration with the world economy, China‟s coastal region was hit directly by weakening external demand during the height of the global financial crisis in 2008. The ripple effect of the slowdown in the eastern areas quickly led to deceleration in the Western and Central regions, despite the small relative size of the exporting sectors in these two regions. However, due to strong efforts by the central and local governments to maintain economic development policies, fixed asset investment growth in these two regions was generally higher than that in the eastern region, leading to higher industrial production and GDP growth. This in turn is driving greater demand for urban services and improved quality of life. 2. China has made impressive efforts to reduce its energy intensity and the environmental impacts of energy use during the 11th Five-Year Plan (FYP) period (2006- 2010) and this is expected to continue in the 12th FYP (2011-2015). In the 11th FYP China adopted an energy intensity per unit of GDP target and reported a 19.1 percent reduction over the five year period. This quantitative and binding target helped reverse the upward trend of energy intensity in the preceding 4-5 years and, importantly, establish energy conservation as a top priority at all levels. During this period, a large number of small inefficient coal-fired power plants and energy-intensive factories have been closed down. Among the other major energy efficiency programs is a central government program of 10 key projects covering a comprehensive list of measures. These measures include building energy efficiency and the replacement of distributed, inefficient, and polluting small coal-fired boilers for heating with central heating supply. These efforts, complemented by flue gas desulfurization campaigns (especially for coal fired power plants), have also helped China move toward its goal of reducing th SO2 emissions by 10 percent over the 11 Five Year Plan. China has declared its commitment to a target of 16 percent energy intensity reduction during the 12th FYP. 3. Due to the size of its population and the nature of its economy, China’s domestic energy efficiency policies significantly bolster global actions in climate change mitigation. On November 26, 2009, China reaffirmed its commitment to addressing climate change mitigation and announced a national goal of reducing CO2 emissions per unit of GDP by 40% to 45% by 2020 from 2005 levels. Continued energy conservation is an integral part of its plan to meet this climate change mitigation target. China included a target of 17% carbon intensity reduction in the 12th FYP. 4. China will continue to face local and global environmental sustainability challenges and energy security concerns as it strives to meet its growing energy needs that fuel rapid economic and social development. One of the major challenges is unprecedented urbanization. While export-oriented, industry-led growth has been the main driver in the growth of energy consumption, rapid urbanization and the emergence of a consumer class with higher requirements for improved living standards are emerging determinants of energy growth. Urban growth in China has spearheaded a well known construction boom. Sixty percent of China‟s

1 building stock in 2006 (about 10 billion m2 of residential area) was built after 1996 and it is estimated that another 60 percent of China‟s building stock in 2030 will be built after 2006.

B. Sectoral and Institutional Context

5. Urumqi is a major economic center in western China but is one of China’s most polluted cities. Urumqi, with a population of 2.3 million, is the capital of the Xinjiang Uyghur Autonomous Region, and has been a principle target for development under the central Government‟s initiatives to develop poorer, western provinces. During the late 1990s, it experienced accelerated growth in its building stock and, commensurately, in urban services. 6. Urumqi is one of 113 polluted cities designated for special attention nationally to improve air quality. Various international studies have shown that excessive air pollution causes premature mortality, morbidity, reduced activity days, chronic respiratory diseases, etc. Children, elderly and the poor are most vulnerable, due to the lack of means for mitigation exposures (either due to weak health or lack of resources). There is a lack of health data available for Urumqi; however, the elevated levels of air pollution are a strong indication of negative health effects on its population. 7. Urumqi has targeted modernization of the district heating sector as a key air pollution mitigation measure. Due to traditional design approaches and low environmental standards enforcement, space heating is estimated to contribute 16% of annual average concentrations of SO2, and 8% of PM10 and NOx, respectively. While heating‟s relative share of pollution load is less than that of industry on an annual average basis, pollution is more severe in winter during 1 the six month heating season. During the 2008 heating season, average SO2 concentrations were three times, and PM10 concentrations were twice as high as national standards. 23% of the district heating plants meet SO2 emission standards. On average, only 50% of winter days comply with applicable air quality standards. As in other cities, heating services follow traditional sector planning, where small and larger dispersed heat only boilers (HOBs) were constructed in the center of new apartment complexes. Overall, the municipality is promoting expanded use of Combined Heat and Power Plants (CHPs) and larger district heating networks, because they are more energy efficient (compared to producing electricity, hot water, and steam separately), reliable, and can absorb the costs of pollution control due to economies of scale. As of 2008, CHPs supplied only 13 percent of the 98 million square meters of total heating floor area of Urumqi. 8. The main fuel for heating is coal. Aside from coal fired CHPs, coal fired district heating boilers supply about 63% of Urumqi‟s heated floor area. Space heating alone is estimated to consume 14% of annual coal consumption in the city. The municipality has increased use of gas for heating, but only in very limited areas where large scale district heating is not feasible. Gas is strictly controlled and mostly imported, raising major security of supply concerns for a vital service such as heating. 9. District Heating in China has a large potential for energy efficiency and for reducing impacts on the environment. Nationally, China‟s urbanization and construction boom is driving growth in demand for heating services in China‟s cold climate provinces. Approximately

1 Tsinghua University Research Center for Energy Efficiency in Buildings, China Building Energy Efficiency Annual Report 2008. 2

550 million people (43% of China‟s population) now live in northern and western provinces where Cold and Severe Cold building code zones apply, and space heating is required by law. By 2005, about 326 out of China‟s 661 cities were equipped with district heating facilities. 2 In the early stages of urbanization, cities invested in small and medium coal-fired boilers to provide space heating to new urban areas. Nearly all older boiler heating systems rely on outdated heating supply system designs with boiler efficiencies of a reported 40-60% (compared to about 75-79% efficiency of larger boilers), and use inferior dust or sulfur removal equipment. They are not hydraulically connected to each other, removing advantages of economies of scale that would make energy efficient operating modes and improved pollution controls cost effective. The impact on human health and city aesthetics, with coal dust and slag in residential centers, and smoke stacks emitting black smoke over apartment buildings, is severely detrimental. 10. District heating in China represents one of the last vestiges of the old-style welfare system in China. The unreformed heating sector presents no incentives for consumers to respond to market-based energy costs because heat, unlike water or electricity, is billed on a flat floor area basis and many state-owned enterprises (SOEs) pay for a share of the heating bill. Reform of urban heating system design, pricing, metering and bill payment systems has been gradually emerging on the national agenda since 2003. In July 2003, the central government issued instructions to move ahead with implementing heat system reform in pilot cities of China‟s 16 northern provinces and autonomous regions, including Urumqi municipality. The goals of heat reform are to „commodify‟ heating by addressing key sector issues: (a) discontinuing employer payment of heating bill and making households responsible for payment of the heating bill; (b) introducing heat metering and billing based on consumption, promoting consumer control of heating and building energy efficiency; (c) developing safe, clean and demand-responsive heat supply systems; (d) reforming heat pricing; and (e) accelerating reform of heating enterprises, consolidating many small enterprises in cities, introducing competition, and fostering and standardizing the heat market. Reforms involve major organizational and institutional challenges at local levels many of which lack the capacity to rapidly overhaul the supply, consumption and billing of heating. Thus, the pace of reform has been less than hoped for, with few buildings charged according to the meter after eight years of reform efforts. 11. Modernization of district heating systems can remove important technical barriers to implementation of district heating sector reform, which has been slower than hoped for. Un-metered space heating has had major negative impacts on design approaches, technology choice and operation of heating systems, and business models. Previously, building codes did not mandate consumer control devices, a pre-requisite for consumers to respond to pricing signals and adjust to desired consumption. Generally, thermal integrity standards were low or weakly enforced. Due to lack of thermostats, existing heating system operation needs to guarantee heating at the furthest part of the network by varying water temperatures at the heating plant. This supply-driven approach results in over-heating of buildings closer to the boiler plant and under heating at the edge of the network – forcing consumers to supplement with more expensive heating (i.e., electricity) or to open windows. It also requires larger pumps and pipelines to guarantee service standards. End-use control devices are now required in new buildings in Urumqi and in its building energy efficiency renovation program. As end use devices become ubiquitous, district heating systems need to switch to a demand-driven operating mode, which varies temperature and water automatically based on energy needs of buildings.

2 IFC consultant report, Co-and trigeneration and heath systems policy report and market research, March 14, 2008. 3

This transition requires enabling technologies, such as frequency controlled pumps, automatic temperature controls and control systems, which will save pumping costs and energy, and in some cases, reduce required pipeline dimensions. With this project, Urumqi would like to create the technical conditions that would enable more rapid adoption of district heating reforms in the future. 12. While the pace of heat reform has been very gradual in Urumqi as in the rest of China, Urumqi has taken some important initial steps in heat reform. Urumqi municipality was included in the World Bank‟s GEF-financed China Heat Reform and Building Energy Efficiency Project (HRBEE). HRBEE requires each pilot heat reform city to submit a city-wide heat reform and building energy efficiency plan. Urumqi‟s plan includes specific targets for more energy efficient buildings such as 16.5 million m2 (about half of projected new construction from 2006) built according to a new 65% energy efficiency standard (which saves 15% more in energy compared with the current 50% national standard) and 13 million m 2 billed according to metered heat by 2011. Urumqi has not achieved these ambitious targets, but the GEF project will continue to provide policy support to accelerate their achievement. 13. District heating has the potential to generate significant local and global environmental co-benefits. In addition to reducing large amounts of local emissions of SO2, significant levels of CO2 can be reduced through modernization of district heating systems. Compared with the baseline, the proposed project could save an estimated 34.5 thousand tons of SO2, 17.7 thousand tons of dust, and 1.9 million tons of CO2 emissions over a five year period (2010 – 2014). Should the CDM be revived, this project could be a strong candidate for carbon financing as a result of its potential carbon reduction emissions. The Bank has already signed two emission reduction purchase agreements for district heating, one of which is similar to the proposed project.

C. Higher Level Objectives to which the Project Contributes

14. The proposed project is consistent with the 2006-2010 Country Partnership Strategy (CPS - discussed by the Executive Directors on May 23, 2006) which seeks, among other themes, to engage China on managing resource scarcity and environmental challenges, through inter alia reducing air pollution and optimizing energy use. The Government of China has requested that the new CPS for 2011-2015 be coterminous with, and aligned to, its 12th Five Year Plan, covering 2011-2015, which will be available in spring 2011. The objectives of the Project are expected to be consistent with the new CPS.

II. PROJECT DEVELOPMENT OBJECTIVES

A. PDO

15. The proposed project development objective (PDO) is to connect consumers in selected districts of Urumqi City to district heating services with improved energy efficiency and environmental performance

4

B. Project Beneficiaries

16. Stakeholders in this project are the Urumqi Municipal Government, district heating companies, and customers. UMG is highly committed to this project. The Vice Mayor in charge of this project is the former PMO director of the successful World Bank transport project. Urumqi Heating Company will benefit from this project as presented in the Financial Analysis (Section VI A). The Borrower has undertaken a social analysis for the project. The vast majority of stakeholders support the project due to its environmental benefits.

C. PDO Level Results Indicators

17. Key results will be measured by the indicators given below. Energy efficiency performance indicators  Reduced standard coal consumption for heating per connected floor area Environmental performance indicators  Reduced dust annual boiler plant emissions per connected floor area 3  Reduced SO2 annual boiler plant emissions per connected floor area 4  Reduced CO2 annual boiler plant emissions per connected floor area

III. PROJECT DESCRIPTION

A. Project components

18. The proposed project consists of three components: (A) Shuimogou District CHP Plant District Heating Network (UHN) Component; (B) Shayibake District CHP Heating Network (SHN) Component; and (C) Institutional Development and Project Management Component. 19. Component A: Shuimogou District CHP Plant District Heating Network (UHN) (estimated cost US$196.8 million; US$56.14 million IBRD financing). The proposed component will finance the construction of the UHN district heating (DH) system. The base heat load of the UHN district heating system will be supplied by the Huadian Weihuliang coal-fired CHP Plant, built in 2009 with a capacity of 2x330 MWp (power output) and 2x350 MWth (heat output). The peak heat load will be supplied by the coal-fired Hualing heat-only boiler (HOB) plant with total heat capacity of 290 MWth owned by Nuan Wanjia Heating Co., Ltd. The total heated floor area supplied by UHN will reach about 14.73 million m2 by 2015, of which about 5.93 million m2 is new planned heating area. After component completion, the DH system will replace use of 14 coal fired heat-only boiler (HOB) plants including 53 coal fired boilers with a total capacity of about 923 MWth component will include construction of: (a) about 55 km of primary and secondary network; (b) a pressure isolation station; (c) about 46 new consumer heating substations and reconstruction of about 45 existing substations (including several building level substations for demonstration purposes); (d) a heat metering station at the CHP plant; (e) a

3 According to the design, desulphurization and dust collection efficiencies will increase from 15% to 90% and from 82% to 99% after environmental upgrading measures for peak load boilers. 4 Referring to the default value of the Intergovernmental Panel on Climate Change (IPCC) 2006, one ton of standard coal can be converted to 2.78 tons of CO2. 5 dedicated monitoring and dispatch system (SCADA) and control center with associated equipment; (f) maintenance vehicles and equipment; and, (g) associated civil and installation works and recovery of public infrastructure damaged by installation (i.e., resurfacing roads). 20. Component A will be implemented in two parts: the 2010 investment program totaling US$44.8 million equivalent, which the municipality has completed with its own funds, and the 2011-2014 investment program totaling US$152.0 million equivalent, which will be supported by the World Bank loan and counterpart funds. 21. Component B: Shayibake District CHP Heating Network (SHN) (estimated cost US$145.0 million; US$42.6 million IBRD financing). The proposed component will finance construction of the SHN district heating (DH) system. The base heat load of the SHN district heating system will be supplied by the Hongyanchi coal-fired CHP Plant (a part of the Guodian Group Ltd.), built in 2010 with a capacity of 2x330 MWp (power output) and 2x350 MWth (heat output). The peak heat load will be supplied by two coal fired HOB plants, Shiyue HOB and Lanzhu HOB with a total installed heating capacity of 311 MWth, owned by Xinjiang Guanghui Heating Co., Ltd and Urumqi Lanzhu Centralized Heating Co., Ltd., respectively. The total heated floor area supplied by SHN will reach about 14.74 million m 2 by 2015, of which about 3.35 million m2 is new planned heating area. After component completion, the DH system will replace use of 31 coal-fired heat-only boiler (HOB) plants including 87 coal fired boilers a total capacity of about 1,368 MWth. The component consists of construction of: (a) about 39 km channel length of primary and secondary network; (b) a pressure isolation station; (c) about 22 new consumer heating substations (including several building level substations for demonstration purposes) and reconstruction of about 28 existing substations; (d) a heat metering station at the CHP plant; (e) monitoring and dispatch system (SCADA) and control center with associated equipment; (f) maintenance vehicles and equipment; and, (g) associated civil and installation works and recovery of public infrastructure damaged by installations (i.e., resurfacing roads). 22. Component B comprises two parts: the 2010 investment program totaling US$58.6 million equivalent), which the municipality has completed and financed with its own funds, and the 2011-2014 investment program totaling US$86.4 million equivalent, which will be supported by the World Bank loan and counterpart funds. 23. Component C: Institutional Development and Project Management (cost US$1.27 million; IBRD financing: US$1.01 million). The institutional development and project management component includes technical assistance, training, study tours and project management support primarily to UDHC, but also to Urumqi municipality, through the following activities: (a) support UDHC project management and monitoring of environmental and social safeguards; (b) study on optimization of a multi-source heat network, its management and monitoring of environmental and energy efficiency performance; (c) update the UHN and SHN emergency plans to enhance safety and reliability; (d) international and domestic study tours for operational knowledge exchange; (e) training of UDHC staff, including on WB policies and project management requirements; (f) IT system to strengthen billing and accounting; and (g) office equipment and related software for UDHC‟s WBPG to strengthen project management.

6

B. Project Financing

1. Lending Instrument

24. The lending instrument is a Specific Investment Loan. The loan will be a United States Dollar - denominated, variable spread loan with a maturity of 30 years including five years‟ grace period, at the Bank‟s standard interest rate for LIBOR-based US dollars, with a Front-end fee of 0.25 percent.

2. Project Cost and Financing

IBRD Cost % Financing Component (million IBRD (million US$) Financing US$) A. Shuimogou District Urumqi CHP Heating Network Component (UHN) 178.50 56.14 31%

B. Shayibake District CHP Heating Network Component (SHN) 131.30 42.60 32%

C. Institutional Development and Project Management 1.30 1.00 77%

Total Baseline Costs 311.10 99.75 32% Physical contingencies 14.50 Price contingencies 10.30

Total Project Costs 335.80 99.75 30% Interest During Construction 6.20 Front-End Fee 0.25 0.25 Initial Working Capital Requirements 0.90 Total Financing Required 343.20 100.00 29%

C. Lessons Learned and Reflected in the Project Design

25. Lessons from Industry Practices. The proposed Project incorporates lessons and innovations from industry practices in China and Europe: (a) promotion of use of waste heat from CHP plants for district heating is considered good practice in Europe and is promoted by the central government in China; (b) demand-driven enabled operation in the primary and the secondary networks allows the system to respond more efficiently to individual customer requirements, saving on pumping and energy costs, compared to traditional supply-driven operating modes; (c) metering across the heating supply chain enables best practice control and optimization, and provides necessary data for calculating two part heat tariffs; (d) building level

7 substations are to be piloted to demonstrate energy efficiency and heating quality benefits associated with linking substations to fewer buildings compared to conventional designs and preferences for larger substations. 26. Approach to Innovation. Experience gained during preparation and implementation of this project will support Bank efforts to promote more energy efficient and less polluting forms of space heating in China. District heating in transition economies has a legacy of being operated by conservative technicians and this is also the case in China. The proposed stepwise approach to innovation and modern technologies through pilots, with policy development support from the GEF HRBEE project for related sector issues such as building energy efficiency and heat pricing, is an established method for introducing new ideas and incubating innovations in China. If successful, the project will contribute to an overall strategy for scaling up modern district heating approaches in Urumqi and other cities. Through a series of projects5, a critical mass of well implemented examples should further accelerate acceptance of new ideas in district heating. This type of project could be replicated in other large cities.

IV. IMPLEMENTATION

A. Institutional and Implementation Arrangements

27. The Bank loan to the People‟s Republic of China will be on-lent to the Xinjiang Uighur Autonomous Region, which will in turn on-lend funds to Urumqi Municipal Government (UMG) following standard arrangements used on similar Bank projects in China. UMG will on-lend the proceeds of the Bank loan to the Urumqi District Heating Company (UDHC) under a Subsidiary Loan Agreement, satisfactory to the Bank. 28. A Project Leading Group (PLG), chaired by the Mayor of Urumqi, has been established by UMG to provide high level guidance to the project and coordinate policy and institutional issues, as needed. The Urumqi International Technical Cooperation Project Office (UPMO) has been established in the Construction Commission and is responsible for overall management and oversight of the proposed Project. 29. The Project will be implemented by the Urumqi District Heating Company (UDHC), a state owned enterprise established in 1984 and the largest DH company in Urumqi. UDHC has established an implementation unit, the World Bank Project Group (WBPG), composed of four units (procurement, finance, engineering management, and operations) with full-time staff from relevant departments within the UDHC. UDHC has set up two divisions, one for each network, to operate and maintain the project assets after their construction.

B. Results Monitoring and Evaluation

30. Annex 1 lists the PDO level results indicators for the project, as well as the intermediate results indicators for each component. UDHC will be responsible for the implementation of monitoring plans, meter calibration, and preparation and submission of periodic monitoring reports to UPMO, including inputs to the semi-annual project progress reports and annual reports on compliance with performance indicators and covenants. It will also report on its business plan

5 About 17 cities are engaged through Bank / GEF supported DH operations. 8 and financial performance. Based on inputs from UDHC, UPMO will evaluate interim results and ensure corrective actions are taken as necessary. UPMO will also submit these reports to the Bank.

C. Sustainability

31. Long term sustainability will depend on effective development of DH/CHP as the main municipal heating energy system with effective and efficient operation and maintenance (O&M). The Project will move the municipal heating system toward sustainability by addressing major energy efficiency and environmental penalties associated with the use of distributed boilers in the city and increasing heat demand by taking advantage of economies of scale through increased coverage of DH/CHP systems. The project will introduce meters and monitoring and control (SCADA) systems which will collect data that, if properly used, could start to build more robust heat load estimates, optimize heating supply operation, help prioritize O&M budgets, and provide referential heat load data for future DH system planning and design. The project also includes technical assistance to improve the capacity of UDHC to operate the new integrated network and optimize network management. 32. The project will also move part of the heat chain into billing based on real energy consumption data. This important institutional change will introduce incentives for further cost containment and energy efficiency. Experience with this stepwise introduction of meter based billing is expected to build confidence and pave the way to switch from existing building floor- based tariffs to heat meter-based retail tariffs, the final step in providing incentives for efficient energy use for heating in the built environment. The project‟s technical assistance will support UDHC to accommodate meter based billing in its billing and accounting system. This should contribute to creating an enabling environment for heating price and billing reform to be more quickly adopted in the city. 33. Although improved efficiency can help lower costs, the reluctance of municipalities to adjust tariffs to offset rising input costs has in the past led to the need for restructuring of heating companies‟ balance sheets. If input cost increases cannot be absorbed by the heating companies, operating performance will suffer and emission controls weakened to reduce costs. A high collection rate is also one of critical issues for DH company development. Thus far, these issues are less pronounced in Urumqi than in other parts of China because the coal price in Urumqi is far lower relative to those in the east. The project includes financial covenants that address financial performance, and operating performance indicators that especially focus on environmental impacts. This combination allows for the retention of an open dialogue during supervision on various aspects of sustainability.

V. KEY RISKS AND MITIGATION MEASURES

34. Project investments are straightforward and the project‟s technical approach is based on standards that are built on existing experience of the Urumqi District Heating Company and Urumqi Municipal Government. While the network design is challenging due to large pressure differences within the new network, the feasibility studies included hydraulic analyses which identified locations where hydraulic separation is needed to regulate network pressure. The municipality has demonstrated during the 2010 construction season its intent to intensively supervise implementation. Technical assistance is provided through the project to address

9

UDHC‟s relative lack of experience in optimizing operation of a DH system with multiple heat sources and distribution companies at this scale. Intensive Bank supervision in the first few years of implementation is planned to support UMG and ensure effective project launch. 35. There has been rioting in the city that has been widely reported in national and worldwide media in July 2009, but since then the situation has stabilized. A social analysis of the project concluded the project enjoys strong support among the local communities. Nevertheless, a traffic management plan has been put in place to address temporary inconveniences associated with network installation and municipal policies addressing potential risks to component results – specifically mitigation of traffic disturbances, re-employment of small boiler workers and heating assistance for the poor – will be included in the project‟s social monitoring plans. These arrangements would help to provide actionable information in the unlikely event that measures do not achieve their intended mitigation objectives. 36. Slow connection rates to the network remain a substantial risk because the municipality‟s boiler closure program is new and the company has little experience with new commercial relationships. The UMG also has a framework in place for the boiler closure program which provides options, including sale of the business to the UMG, conversion to a distribution business and purchase heat from the new network, closure of unlicensed boilers with a right to keep land with changed zoning. The commercial agreements were reviewed by the Bank team. While they fall short of international practices they are considered an improvement over prevailing Chinese contractual arrangements in the heating sector. Key performance indicators will also be used as part of supervision to monitor financial performance. The Bank team plans to engage the UDHC after construction of the network on approaches to consumer services as part of supervision.

VI. APPRAISAL SUMMARY

A. Economic and Financial Analysis

Economic Analysis

37. This project is about changing the way apartments are heated before, using dispersed large and small inefficient and polluting boilers, connecting them to CHP-based district heating networks. This new system improves energy efficiency and environmental performance of the DH system resulting in coal savings and reduction of pollution compared to the baseline. The economic analysis of the project compares the with-project and without-project alternatives, taking into account all comparable costs of the two. Project alternatives include: (a) base load from coal-fired CHPs and peak load from coal-fired HOBs; and (b) construction of the heat transmission and distribution system as in the project description. The without-project alternative includes: (a) the continuation of existing heating methods based on local coal-fired boilers, and (b) new coal-fired boilers for new building areas (these boilers would have emission reduction equipment to fulfill current environmental requirements). 38. A cost-benefit analysis was conducted to estimate the economic internal rate of return (EIRR) of the project compared to the without-project alternative. The economic costs include the total investment costs of both alternatives. The major benefits were estimated by taking into account the following: (i) fuel efficiency improvements generated by replacing local, inefficient

10 coal-fired boilers by heat supply from the CHP plants; (ii) reduced heat losses generated by improving existing substation; (iii) operation, maintenance and repair costs variances for both alternatives; and (iv) environmental benefits of reduced dust, SO2 and CO2 emissions as a result of the project. In the base case, the project EIRR is 21.3%. Sensitivity analysis on the impact of increased investment costs, reduced benefits and importance of environmental benefits, indicate that if investment costs increase by 20 percent, the EIRR would be 15.3%, while the EIRR would be 19.1% with benefits reduced by 20%. Without environmental benefits, the EIRR would be 11.7%.

Financial Analysis

39. Project financial analysis. The project‟s financial viability has been assessed by comparing the financial rates of return (FRRs) for the SHN and UHN investment components and for the combined project as a whole with their respective weighted average cost of capital (WACC). The financial analysis resulted in an FRR of 8%. The FRRs are higher than the WACC for each component and for the combined project. The project FRR also meets Government‟s feasibility study guidelines on required rates of return for similar public infrastructure projects. The FRRs are adequate for enabling UDHC to maintain an overall satisfactory financial performance, and meet the agreed financial performance indicators. Sensitivity analysis in regard to the effect on the FRRs of variations in key variables has been carried out. Further details are given in Annex 7 to the PAD. 40. Financial sustainability. During the period 2007 to 2009, UDHC reported profitable operations. During the project implementation period, UDHC will be undertaking a major investment program, including the proposed World Bank financed project, which will result in a very substantial increase in its operations. This will result in large increases in the levels of its operating expenses and debt service, and will require UDHC to correspondingly increase its annual revenues. Key factors that affect UDHC‟s revenue generation are: (i) the rate of growth of heat demand; (ii) heat sales tariffs adequate to cover any increases in operating expenses, including heat purchase costs; (iii) revenue collection performance; and (iv) continuing to achieve greater efficiency in its operations and maintenance (O&M) expenses. 41. A detailed analysis, including financial projections, of UDHC‟s financial performance in the period 2010 to 2020 has been carried out, and is kept in the Project Files. A summary of results and key indicators is provided in the Annex 7. The projections indicate that, subject to UDHC and the Government undertaking the specified actions to mitigate possible risks (discussed above in Section V), UDHC should be able to generate sufficient revenues each year to meet its financial obligations to cover its (a) cash operating expenses, (b) debt service, and (c) agreed contributions to investment financing, and to meet the financial performance indicators listed below. 42. Financial performance monitoring and financial covenants: To monitor UDHC‟s performance in meeting its financial obligations, the following indicators are proposed to be used: (a) A working ratio (cash operating expenses/collected revenues) of not higher than 90%; (b) A current ratio (current assets/current liabilities) of not less than 1.3; and

11

B. Technical

43. Detailed feasibility studies prepared for the two district heating areas define the technical solutions, pipeline routes and locations for the pressure isolation stations, as well as investment costs for all sub-components and expected benefits. All proposed technical solutions are based on well tested solutions and equipment with mature technologies. In 2010, UDHC successfully implemented part of the system which already supplies heat from the CHP plants to final customers. 44. After project completion, 45 coal-fired local boiler plants, including 140 coal-fired boilers with about more than 2291 MWth in the city center, will no longer operate. This will reduce coal consumption in downtown Urumqi. The base load heat will be generated by coal-fired CHP plants, located outside the city center, and the peak load by coal-fired peak load boilers. The 6 peak load boilers will be equipped with flue gas cleaning equipment for SO 2 and dust removal. These will be financed by the owners of the peak load boiler plants and are outside the project scope. 45. Urumqi‟s unique geological topology, featuring a high elevation difference over 150 meters between heating plants and consumers, requires special attention on system design for safe operation of the two networks. The DH system design has to ensure the following three conditions everywhere: (a) no over-pressure; (b) no water evaporation due to low pressure; and (c) no vacuum. Because of the high elevation difference between the CHP and the consumer area, a three hydraulic separated network system has been designed with heat exchanger stations to meet these three conditions: (a) the primary network from the CHP to the pressure isolation stations, with a design pressure of 2.5MPa and a temperature of 135°C; (b) the secondary network from the pressure isolation stations to the consumer heating substations, with a design pressure of 2.5-1.6MPa and a temperature of 120 °C; and (c) the heat distribution network from the heating substations to the radiators inside the buildings, with a design pressure of 1.0MPa and a temperature of 90°C. 46. Pre-insulated pipes will be used in Bank financed components and directly buried for primary and secondary networks with some compensators. Sectioning valves will be installed every 2-3 kilometers along the main transmission lines and at each pipeline branch for ease of maintenance. The project design consultant has experience with the design of large pipeline networks based on the non-compensation method. 47. Heating substations, new and renovated, will include heat exchangers to separate heat distribution networks from heat transmission networks. Substations will have heat meters and local automation systems to optimize the operation of substations and regulate water temperatures to buildings in accordance with weather conditions. All substations will also be connected to the company-wide monitoring and dispatching system (SCADA) which allows operators to remotely change parameters at each substation. The dispatch center will monitor and dispatch heat supply from the CHP plants and the peak load boiler plants to optimize operation, hydraulic situation, and to maximize reliability of heat supply to customers. 48. Heat metering systems have been designed at different heat supply levels. Heat meters are installed at CHPs and peak load boiler plants, and will be installed in all heating substations. All

6 The CHPs already have emission control equipment installed and operating. 12 new buildings will have building level heat meters to facilitate the future switch to consumption based billing.

C. Financial Management

49. The Bank loan proceeds and the oversight of the Designated Account will be managed by the Xinjiang Uyghur Autonomous Region Finance Bureau (XRFB). A financial management capacity assessment was conducted by the Bank and actions to strengthen project financial management capacity have been agreed with the relevant implementing agencies. The financial management assessment concluded that, with the implementation of these proposed actions, the financial management arrangements would satisfy the Bank‟s minimum requirements under OP/BP 10.02. Annex 3 provides additional information on financial management.

D. Procurement

50. UITCPO Procurement Assessment. The Urumqi International Technical Cooperation Project Office (UITCPO) will be responsible for ensuring that the obligations of UMG under the Project Agreement are executed. UITCPO will: a) play the leading and coordinating roles in project implementation and procurement activities; b) provide guidance to UDHC on procurement and contract management; c) review procurement documents prepared by UDHC; and d) supervise and monitor procurement activities carried out by UDHC. Staffing in UPMO is adequate for the nature and extent of procurement work envisaged under the project. 51. UDHC Procurement Assessment. Procurement will be carried out by the Urumqi District Heating Company (UDHC). The UDHC World Bank Project Group (WBPG) includes a procurement unit. Four full-time procurement staff in place have substantial experience in procurement of locally funded projects, but have no direct experience with Bank-financed projects. All four procurement staff have attended the World Bank procurement training course. UDHC is capable of managing large infrastructure contracts. 52. The procurement risk is UDHC‟s lack of experience in procurement of Bank-financed projects. This risk will be mitigated through: close coordination with UPMO and guidance from UPMO; targeted training and capacity building of UDHC staff; and close supervision by UITCPO and the Bank. 53. UDHC has prepared a procurement plan for the initial 18 months of the project, which is acceptable to the Bank.

E. Social (including safeguards)

54. A project social analysis identified the project stakeholders (citizens, religious people, shop keepers, communities, schools, hospitals, local markets, mosques, heating company employees, municipal departments in charge of traffic management, and PMO) and through broad participation of project stakeholders, public consultations, interviews, focus group discussions, and substantial data gathering and analysis, concluded that all groups fully supported the project. Stakeholder concerns focused on three major issues: traffic disturbance during construction; workers affected by the small boilers closure program; and impact of heat pricing on low-income families. Based on the social analysis, the following documents have been prepared: traffic

13 management plan; emergency management plan (e.g., water main breaks from installation); monitoring plan for municipal policy addressing workers affected by its small boilers closure program; and monitoring plan of UMG‟s policy to protect low-income families from unexpected increases in heat pricing. 55. Urumqi has more than 50 different Chinese ethnic minorities or groups: (Uygurs, Han, Kazaks, Kirgiz, Mongols, etc) totaling 637,000 people, about 27% of population. 75% of them live in the inner-city area and the rest in peri-urban areas. Most of these populations have immigrated to Urumqi since 1951. The characteristics of indigenous peoples listed in the Bank‟s OP 4.10, Indigenous Peoples, are not found in the project area. In particular, they are neither considered to have collective attachment to ancestral territories in the project area nor have they faced forced severance from these ancestral lands. The Indigenous Peoples policy is therefore not triggered. 56. Since the Bank-financed pipelines will dispatch heat from two existing plants and will be connected to the main heating network financed and installed by Urumqi in 2010, a due diligence review was conducted on the two plants and the main heating network. The two plants were built more than 10 years ago and their expansions were completed respectively in 2008 and 2010 on company-owned lands without involving any resettlement. The due diligence review concluded that small scale resettlement activities for the installation of the main heating network financed by Urumqi in 2010 were in compliance with Bank policies. 57. The project design has avoided land acquisition and involuntary resettlement. A resettlement policy framework has been prepared to address the land acquisition and resettlement impacts of any changes to the project design.

F. Environment (including safeguards)

58. The proposed project is a Category A project as per the Bank OP/BP 4.01. By eliminating the use of locally polluting heat boilers and connecting to an integrated heating system supplied by CHP plants and peak load boilers with strengthened emission controls, the project is expected to contribute to a net reduction of coal consumption and associated emissions. 59. Temporary moderate environmental impacts are foreseen during the construction phase, such as noise, dust, solid waste disposal, worker safety, social and traffic disturbance, and chance finds of cultural relics. Standard measures to mitigate the typical impacts of construction activities are described in the Environmental Assessment (EA) and in the Environment Management Plan (EMP). 60. The EMP includes a traffic management plan and appropriate mitigation measures identified during the social analysis process. Good practices from the 2010 construction program will be continued, e.g., distribution of a bilingual (in Chinese and Uyghur) information booklet about construction activities, schedule, and alternative routes to affected residents. 61. A due diligence review conducted on the construction work carried out in 2010 found that the work had been executed consistent with Bank environmental safeguard policies. A due diligence review of existing facilities (two CHP plants and three peak load boiler houses) that will supply heat to the project networks carried out during project preparation concluded that these facilities are compliant with national and local emission standards, as well as with those of the WB/IFC Environmental Health and Safety (EHS) guidelines.

14

62. Environmental Assessment (OP 4.01). Following the requirements of Bank OP 4.01 and relevant domestic regulations, the project includes an EA for each of the two project networks. Each EA presents baseline environmental and socio-economic conditions, impact assessment, alternative analysis, public consultation process, and the EMP. An executive summary of each EA was prepared in line with Bank requirements for Category A projects. Annex 3 provides more details on the EAs and the EMPs.

G. Other Safeguards Policies triggered (if required)

63. Not applicable.

15

Annex 1: Results Framework and Monitoring Project Development Objective (PDO): The proposed project development objective (PDO) is to connect consumers in selected districts of Urumqi to district heating services with improved energy efficiency and environmental performance.

Cumulative Target Values** Responsibility Description PDO Level Results Unit of Data Source/ (indicator Baseline YR 1 YR 2 YR3 YR 4 YR5 Frequency for Data Indicators* Core Measure Methodology definition etc.) (2010) (2011) (2012) (2013) (2014) Collection Indicator One: Energy tce / annual Note 8 see below. UDHC efficiency performance million indicator7: Reduced annual m2 0 4.9 5.1 5.1 5.1 5.1 boiler plant coal consumption for heating per connected floor area. Indicator Two: tons/ annual Note see below. UDHC Environmental performance million indicators: Reduced SO m2 2 0 245 247 248 248 248 annual boiler plant emissions per connected floor area. Indicator Three: tons/ annual Note see below. UDHC Environmental performance million indicators: Reduced dust m2 0 127 128 129 129 129 annual boiler plant emissions per connected floor area. Indicator Four: tons/ annual Note see below. UDHC Environmental performance thousand indicators: Reduced CO m2 2 0 13.7 14.0 14.1 14.1 14.1 annual boiler plant emissions per connected floor area. Indicator Five: Financial percent annual Note see below. UDHC performance indicators: ------≤90 ≤90 ≤90 Maintain working ratio not higher than 90%

7 All the above PDO indicators are calculated by comparing coal consumption and emissions of the without-project alternative to the with-project alternative. The difference (reduction of coal consumption and emissions) is divided by the connected floor area. 8 Calculated according to CDM methodology AM0058 based on actual data records as applicable. 16

INTERMEDIATE RESULTS Intermediate Result (Component One): Shuimogou District Urumqi CHP Heating Network Component (UHN) All indicators are cumulative from the beginning of the project.

Intermediate Result Million annual Note 9see below. UDHC Indicator One: Connected m2 0 1.0 9.0 13.0 14.0 14.7 heated area to UHN network Intermediate Result Km of annual Note see below. UDHC Indicator Two: Kilometers pipelines 0 20 35 45 50 54 of pipelines installed. Intermediate Result Number annual Note see below. UDHC Indicator Three: of Construction of new stations 0 0 1 1 1 1 pressure regulating stations (large substation). Intermediate Result Number annual Note see below. UDHC Indicator Four: Number of of sub- 0 10 60 80 90 90 substations constructed or stations rehabilitated. Intermediate Result (Component Two): Shayibake District CHP Heating Network (SHN)

Intermediate Result Million annual Note see below. UDHC Indicator One: Connected m2 0 5.0 8.0 13.0 14.0 14.7 heated area to SHN network Intermediate Result Km of annual Note see below. UDHC Indicator Two: Kilometers pipelines 0 20 30 35 39 39 of pipelines installed. Intermediate Result Number annual Note see below. UDHC Indicator Three: of Construction of a pressure stations 0 0 1 1 1 1 regulation station (large substation). Intermediate Result Number annual Note see below. UDHC Indicator Four: Number of of sub- 0 15 30 45 50 50 substations constructed or stations rehabilitated.

9 Recorded at the start of the project and whenever newly installed pipelines or equipment start operation. 17

Intermediate Result (Component Three): Institutional Development and Project Management. All indicators are cumulative from the beginning of the project.

Intermediate Result Set of Ongoing TOR of HRBEE Equip- annual NA UDHC Indicator One: TA HRBEE HRBEE assess- ment Strengthening the billing activities assess- assess- ment installed and accounting system of ment ment study and used UDHC. study study available; available Procure and carry out equipment installa- tion Intermediate Result Set of Draft Draft Draft Selection Draft Final annual NA UDHC Indicator Two: Technical TA TOR TOR TOR of Final Report assistance to UDHC and activities available available available Consul- Report available study of how to optimize the tant and available multi-heat source operation, Inception management and Report monitoring. available Intermediate Result Number 14 17 20 annual NA UDHC 7 Indicator Three: Number of of study domestic domestic domestic 0 0 domestic study tours implemented. tours 2 2 2 1 internatl internatl internatl internatl

18

Annex 2: Detailed Project Description

1. The proposed project consists of three components: (A) Shuimogou District Urumqi CHP Power Plant Heating Network (UHN) Component; (B) Shayibake and Tianshan Districts CHP Heating Network (SHN) Component; and (C) Institutional Development and Project Management Support Component. The total estimated project costs are 3 RMB billion (US$343.2 million equivalent). The proposed indicative financing plan includes an IBRD loan of US$100 million, about 30% of total estimated project costs, which is proposed to partially finance investment and technical assistance costs. The municipality has implemented part of this investment program in 2010, which amounts to about US$100 million equivalent or about 30% of total estimated project costs. Investments in 2010 were financed from own sources including loans from local commercial banks. 2. The Urumqi District Heating Company (UDHC), a municipal State Owned Enterprise, is proposed to be the IBRD sub-borrower and will implement the project under the overall supervision of UMG. UDHC will own and operate the newly integrated district heating networks. 3. Technical Approach. Typically, a district heating system involves three main components, a heat source, heat transmission (“primary”) network and heat distribution to buildings through heating substations. Heat sources generate high temperature hot water which circulates in a closed loop system, transmitting heat energy through substations to a secondary closed loop network, which in turn transmits lower temperature water (for safety) to heating elements (radiators, floor heating, etc.). Heat sources in this project are Combined Heat and Power Plants and Heat Only Boilers (HOBs) which produce high temperature water for the primary network. 4. By supporting the development of an integrated CHP-HOB system, the project will improve the performance and quality of district heating services in Urumqi and have a major impact on improving air quality in the city. On project completion, 45 coal-fired local boiler plants, including 140 coal-fired boilers with about more than 2,291MWth in the city center, will no longer operate. This will reduce coal consumption in downtown Urumqi. The base load heat will be generated by coal-fired CHP plants, located outside the city center, and the peak load by coal-fired peak load boilers. The peak load boilers will be equipped with flue gas cleaning 10 equipment for SO2 and dust removal. These will be financed by the owners of the peak load boiler plants and are outside the project scope. 5. Technical challenges and design. Urumqi has a unique geological topology featuring a high elevation difference over 150 meters between heating plants and consumers. For safe operation, the DH system design has to ensure the following three conditions everywhere: (a) no over- pressure; (b) no water evaporation due to low pressure; and (c) no vacuum. Because of the high elevation difference between the CHP and the consumer area, a three hydraulic separated network system was designed with heat exchanger stations to meet these three conditions. They are: (a) the primary network from the CHP to the pressure isolation stations with a design pressure of 2.5MPa and a temperature of 135°C; (b) the secondary network from the pressure isolation stations to the consumer heating substations with a design pressure of 2.5-1.6MPa and a temperature of 120°C; and (c) the heat distribution network from the heating substations to the radiators inside the buildings with a design pressure of 1.0MPa and a temperature of 90°C.

10 The CHPs already have emission control equipment installed and operating. 19

6. Pre-insulated pipes will be used in Bank financed components and directly buried for primary and secondary networks with some pipe expansion compensators. Sectioning valves will be installed every 2-3 kilometers along the main transmission lines and at each pipeline branch for ease of maintenance. The project design consultant has experience with the design of large pipeline networks based on the non-compensation method. 7. The heating substations, new and renovated, will include heat exchangers to separate heat distribution networks from heat transmission networks. Substations will have heat meters and local automation systems to optimize the operation of the substations and regulate water temperatures to the buildings in accordance with weather conditions. All substations will also be connected to the company-wide monitoring and dispatching system (SCADA) which allows operators to remotely change parameters at each substation. The dispatch center will monitor and dispatch the heat supply from the CHP plants and the peak load boiler plants to optimize operation, hydraulic situation, and to maximize reliability of heat supply to customers. 8. Heat metering systems have been designed at different heat supply levels. Heat meters are installed at CHPs and peak load boiler plants, and will be installed in all heating substations. All new buildings will have building level heat meters to facilitate the switch to consumption based billing in the future. 9. Component A: Shuimogou District CHP Plant District Heating Network (UHN) (estimated cost US$196.8 million; US$56.14 million IBRD financing). The proposed component will finance the construction of the UHN district heating (DH) system. The base heat load of the UHN district heating system will be supplied by the Huadian Weihuliang coal-fired CHP Plant, built in 2009 with a capacity of 2x330 MWp (power output) and 2x350 MWth (heat output) and owned by Huadian Group, Ltd. The peak heat load will be supplied by the coal-fired Hualing Boiler Plant (6x29MWth and 2x58MWth, in total 290 MWth) owned by Nuan Wanjia Heating Co., Ltd. of the Hualing Group Heating Company, Ltd. The total heated floor area supplied by UHN will reach about 14.73 million m2 by 2015, of which about 5.93 million m2 is new planned heating area. The total heat load will be about 973 MWth. After component completion, the DH system will replace the use of 14 coal fired HOB plants (9 larger plants totaling about 886 MW th and 5 smaller plants totaling about 36 MWth) including 53 coal fired boilers with a total capacity of about 923 MWth. 10. The component will include construction of: (a) about 55 km of primary and secondary network; (b) a pressure isolation station; (c) about 46 new consumer heating substations (including several building level substations for demonstration purposes) and reconstruction of about 45 heating substations; (d) construction of a heat metering station in CHP, (e) construction of a dedicated monitoring and dispatch system (SCADA) and control center, including associated equipment; (f) maintenance vehicles and equipment; and (g) associated civil and installation works and recovery of public infrastructure damaged by installation (i.e. resurfacing roads). 11. Component A will be implemented in two parts. The 2010 investment program totaling US$44.8 million equivalent, which the municipality has already completed including the following: (a) Construction of 22.4 km of district heating network from the CHP plant. (b) Connection of 1.190 million m2, including 1.07 million m2 of new buildings.

20

(c) Connection to 10 substations, including construction of 7 new and reconstruction of 3 substations. (d) Heat metering station at CHP and pressure regulation substation. (e) Associated civil and installation works and recovery of public infrastructure. This part of the new system will replace the use of 3 HOB plants with 6 coal-coal fired boilers (22 MWth). 12. The 2011-2014 investment program totaling US$152.0 million equivalent, which will be supported by the World Bank loan and counterpart funds, includes the following: (a) Construction of about 32.4 km of district heating network. (b) Connection of about 13.54 million m2, including 8.68 million m2 of existing buildings, and 4.86 million m2 of new buildings. (c) Connection to about 81 substations belonging to UDHC, including construction of 39 new (including several building level substations for demonstration purposes) and reconstruction of 42 substations, as well as connection to about 69 substations belonging to the heat distribution companies. (d) Construction of SCADA and control center, including associated equipment. (e) Maintenance vehicles and equipment. (f) Associated civil and installation works and recovery of public infrastructure. This part of the new system will replace the use of 11 HOB plants with 47 coal-coal fired boilers (901 MWth). 13. This implementation schedule is presented in the table below:

A. Shuimogou District Urumqi CHP Heating Network Component (UHN)

2010 2011 2012 2013 2014 Total Connected heating area [million m2] 1.19 8.03 4.2 0.79 0.52 14.73 Connected heating area existing buildings 0.12 6.88 1.8 0 0 8.8 Connected heating area new buildings 1.07 1.15 2.4 0.79 0.52 5.93 Pipeline length installed [km] 22.4 18.7 8.7 4.2 0.8 54.9 Number of connected heat exchanger stations 10 97 43 6 4 160 New substations 7 14 15 6 4 46 Reconstructed substations 3 40 2 0 0 45 Number of substation belonging to others 0 43 26 0 0 69 Number of HOBs 6 23 24 0 0 53 number of boilers closed 6 23 24 0 0 53 Capacity of closed boilers [MW] 22 683 218 0 0 923

21

14. The corresponding cost estimate is shown in the table below:

A. Shuimogou District Urumqi CHP Heating Network Component (UHN) （ in US$ millions equivalent ） Total 2010 2011-2014 Network Pipelines 108.6 32.8 75.8 Primary pipelines 44.4 19.5 24.9 Secondary pipelines 60.0 13.2 46.8 Distribution pipeline replacement 4.2 0.1 4.1 Primary Network Pressure Regulation 14.7 3.5 11.2 Heat Metering Station 0.1 0.1 0.0 Pressure Isolation Station 14.6 3.4 11.2 Control Center for UDHC 7.9 0.0 7.9 Substations and Metering 18.3 0.9 17.4 New Substations 9.3 0.7 8.6 Substation Rehabilitation 3.8 0.2 3.6 Building level substations 0.7 0.0 0.7 Substation automation/SCADA 3.9 0.0 3.9 Meters at former Boiler Site 0.6 0.0 0.6 Other 29.1 3.7 25.4 Land acquisition 4.7 0.4 4.3 Road restoration 6.5 1.6 4.9 Other engineering expenses 17.9 1.7 16.2 Total Base Cost 178.5 3.9 174.6 Contingencies 14.3 3.3 11.0 Interest during construction 3.6 0.6 3.0 Initial Working Capital 0.5 0.0 0.5 Total - UHN Component 196.8 44.8 152.0

15. Component B: Shayibake District CHP Heating Network (SHN) (estimated cost US$145.0 million; US$42.6 million IBRD financing). The proposed component will finance construction of the SHN district heating (DH) system in the Shayibake District of Urumqi. A small part of the Shayibake District CHP Heating Network will also cross into neighboring Tianshan District. The base heat load of the SHN district heating system will be supplied by the Hongyanchi coal-fired CHP Plant, built in 2010 with a capacity of 2x330 MWp (power output) and 2x350 MWth (heat output), and owned by the Guodian Xinjiang Hongyanchi Power Generation Co., Ltd., a part of the Guodian Group, Ltd. The peak load will be supplied by the Shiyue HOB Plant (5x29MWth) operated by the Xinjiang Guanghui Heating Co., Ltd., and the Lanzhu HOB Plant (4x29 MWth + 1x64MWth) operated by the Urumqi Lanzhu Centralized Heating Co., Ltd. The total heated floor area supplied by SHN will reach about 14.74 million m2 by 2015, of which about 3.35 million m2 is new planned heating area. The total heat load is about 1,010 MWth. After component completion, the DH system will replace the use of 31 coal-fired

22

HOB plants (about 11 larger boiler plants and 20 smaller coal-fired HOB plants) including 87 coal fired boilers with a total capacity of about 1,368 MWth. 16. The component consists of construction of: (a) about 39 km channel length of primary and secondary network; (b) a pressure isolation station; (c) about 22 new consumer heating substations (including several building level substations for demonstration purposes) and reconstruction of about 28 existing substations; (d) a heat metering station at the CHP plant; (e) monitoring and dispatch system (SCADA) and control center with associated equipment; (f) maintenance vehicles and equipment; and, (g) associated civil and installation works and recovery of public infrastructure damaged by installations (i.e. resurfacing roads). 17. Component B includes two parts. The 2010 investment program totaling US$58.6 million equivalent, which the municipality has already completed and financed with its own funds including the following: (a) Construction of 22.6 km of district heating networks. 2 2 (b) Connection of 5.62 million m including 0.74 million m of new buildings.

(c) Connection to 16 substations belonging to UDHC, including construction of 1 new and reconstruction of 15 substations, and 56 substations belonging to the heat distribution companies. (d) Heat metering station at CHP and pressure regulation substation. (e) Associated civil and installation works and recovery of public infrastructure. This part of the new system will replace use of 18 HOB plants with 43 coal-coal fired boilers (577 MWth) 18. The 2011-2014 investment program, totaling US$86.4 million equivalent, which will be supported by the World Bank loan and counterpart funds, includes the following: (a) Construction of about 16.8 km of district heating networks. (b) Connection of 9.13 million m2, including 6.53 million m2 of existing buildings and 2.61 million m2 of new buildings. (c) Connection to 34 substations belonging to UDHC, including construction of 21 new (including several building level substations for demonstration purposes) and reconstruction of 13 substations, and 78 substations owned by the heat distribution companies. (d) Construction of SCADA and control center, including associated equipment. (e) Maintenance vehicles and equipment. (f) Associated civil and installation works and recovery of public infrastructure This part of the new system will replace the use of 13 HOB plants with 44 coal-coal fired boilers (790 MWth). 19. This implementation schedule is presented in the table below:

23

B. Shayibake District CHP Heating Network Component (SHN)

2010 2011 2012 2113 2114 Total Connected heating area [million m2] 5.61 3.44 5.69 0 0 14.74 Connected heating area existing buildings 4.87 2.75 3.78 0 0 11.40 Connected heating area new buildings 0.74 0.69 1.92 0 0 3.35 Pipeline length installed [km] 22.6 9.0 7.8 0.0 0.0 39.5 Number of connected heat exchaner stations 72 50 62 0 0 184 New substations 1 7 14 0 0 22 Reconstructed substations 15 12 1 0 0 28 Number of substation belonging to others 56 31 47 0 0 134 Number of HOBs 18 9 4 0 0 31 Number of boilers closed 43 25 19 0 0 87 Capacity of closed boilers [MW] 577 430 361 1368

B. Shayibake District Urumqi CHP Heating Network Component (SHN) （ in US$ millions equivalent ） Total 2010 2011-2014 Network Pipelines 81.2 43.0 38.2 Primary pipelines 59.9 43.0 16.9 Secondary pipelines 17.7 0.0 17.7 Distribution pipeline replacement 3.6 0.0 3.6 Primary Network Pressure Regulation 9.6 0.1 9.5 Heat Metering Station 0.1 0.1 0.0 Pressure Isolation Station 9.6 0.0 9.6 Substations and Metering 12.4 3.1 9.3 New Substations 4.0 0.2 3.8 Substation Rehabilitation 3.1 1.9 1.2 Building level substations 0.9 0.0 0.9 Substation automation/SCADA 2.1 0.0 2.1 Meters at former Boiler Site 2.1 1.0 1.1 Other 28.1 7.2 20.9 Land acquisition 10.6 2.2 8.4 Road restoration 4.5 2.2 2.3 Other engineering expenses 12.9 2.8 10.1 Total Base Cost 131.3 5.2 126.1 Contingencies 10.5 4.3 6.2 Interest during construction 2.7 0.9 1.8 Initial Working Capital 0.4 0.0 0.4 Total - UHN Component 145.0 58.6 86.4

20. Component C: Institutional Development and Project Management (cost US$1.27 million; IBRD financing: US$1.01 million). The component includes technical assistance, training, study tours and project management support primarily to UDHC but also to Urumqi municipality through the following activities described below:

24

TA1 (US$701,000, IBRD: US$448,000): Consultant Services

21. TA1.1 (US$254,000, NBF): Provision of consultant services to strengthen the capacity of UDHC‟s World Bank Project Group (WBPG) to implement the proposed Project. Three contracts will be signed by the UDHC:  Project management: to provide support to WBPG on project management, procurement, project reporting to the Bank, and training.  Contracts for the two third-party monitoring consultants (for social and environmental safeguards). 22. TA1.2 (US$448,000, IBRD): Study to optimize the multi-heat source operation, management and monitoring to improve environmental performance and energy efficiency and to understand requirements for the integration of the UHN and SHN networks to the current municipal district heating network. In addition, UDHC will update its emergency plan for an integrated network (such as during a power outage or water hammers) to improve safety and reliability.

TA 2 (US$153,000, IBRD): International and Domestic Study Tours

23. This sub-component will include a number of international and domestic study tours and related training for UDHC staff and Urumqi municipality. The proposed destinations for the international tours include Denmark and Germany. Topics to be covered include: (a) application of new building / apartment level technologies; and (b) operation and management of large scale heating networks; and (c) application and management of peak-load boilers in CHP networks. Proposed destinations for domestic tours include Northern China, North-Eastern China, and Shandong. Topics to be covered include: (a) application of heat exchange units; (b) heat metering and payment collection; (c) application of energy contract management for district heating; and (d) advanced technologies for emergency repairs of heating pipes.

TA 3 (US$129,000, IBRD): Domestic Training

24. TA 3.1 (US$54,000, IBRD): Training on district heating sector issues. This sub- component will include a number of training activities for UDHC staff and Urumqi municipality on district heating sector issues. Most of the training courses will be delivered in Urumqi. Proposed topics to be covered include: (a) large scale heating network dispatch and supervision control; (b) construction management; and (c) maintenance and management of PLC control system. 25. TA 3.2 (US$75,000, IBRD): Training on project management. This subcomponent will include a number of training activities for WBPG staff and Urumqi municipality on World Bank policies and procedures. Most of the training courses will be delivered in Urumqi and in Beijing. The proposed topics to be covered include: (a) financial management; (b) procurement; and (c) social and environmental safeguards.

25

TA 4 (US$284,000, IBRD): Provision of Equipment

26. TA 4.1 (US$179,000, IBRD). Provision of software to strengthen UDHC billing and accounting systems. This sub-component will invest in information technology to integrate UDHC‟s billing and accounting systems and make them compatible with the anticipated consumption based billing. This component is a follow up to the ongoing assessment study financed by the HRBEE GEF Project. 27. TA 4.2 (US$104,000, IBRD). Provision of office equipment and software related to WBPG and Urumqi municipality project implementation activities.

26

Annex 3: Implementation Arrangements

Project Institutional and Implementation Arrangements

1. Urumqi District Heating Company. The Urumqi District Heating Company (UDHC) is owned by the Urumqi State Property Commission and was established in 1984. It currently is the largest district heating company in Urumqi among 44 heating companies and logistics units providing heating. It employs 654 staff, including 57% percent with university degrees and 10% percent engineers. 2. Weidian Network (Shuimogou). UDHC owns and operates one boiler plant (256 MW) with 40 km of network and 109 substations covering 7.08 million m2 of heating area. 3. Nan Qu Network (Shayibake). UDHC owns and operates 47 km of network and 125 substations covering 7.92 million m2 of heating area. The two boiler plants (with a capacity of 450MW each) and the peak-load boilers supplying the network are operated by other companies, owned by the Urumqi State Property Commission. 4. The organizational chart of UDHC is provided below:

5. Project Agreement. The Project Agreement will be signed by UMG and the Bank. UMG is the government body directly responsible for project management and causing UDHC to implement the project according to the Loan and Project Agreement. 6. Loan Agreement. The World Bank Loan Agreement will be signed between the World Bank and the People‟s Republic of China through its Ministry of Finance (MOF). On-lending arrangements for the loan will be signed between the Central Government through MOF and the

27

Xinjiang Autonomous Regional Government through its RFB, and then between RFB and UMG through its MFB, and finally between MFB and UDHC. 7. Subsidiary Loan Agreement. UMG will sign a Subsidiary Loan Agreement (SLA) with UDHC. The SLA will include project implementation obligations of UDHC as well as the terms and conditions of the on-lending. Signing an SLA, satisfactory to the Bank, will be a condition of disbursement. 8. On-lending Terms. UMG will on-lend funds to UDHC under the same terms and conditions as provided for in the World Bank Loan Agreement. 9. Project Leading Group. In order to provide high-level support and ensure smooth project implementation, a Project Leading Group (PLG) has been established by UMG. The PLG is headed by the Mayor of Urumqi and is composed of leaders of about 29 provincial and municipal level government agencies.11 During project preparation and implementation it is called upon the request of the PLG Office when important issues arise that the PLG Office cannot resolve. The PLG Office, chaired by the Party Secretary of the UMG Construction Commission and comprising key officials from the UMG Construction Commission and UDHC will provide overall executive leadership to the Urumqi International Technical Cooperation Project Office (UITCPO) and UDHC for project preparation and implementation. 10. Project Management and Oversight. The Urumqi International Technical Cooperation Project Office (UITCPO), established within UMG Construction Commission, will be the primary body responsible for ensuring that the obligations of UMG under the Project Agreement are executed. These include: (a) overall project management, and oversight of obligations undertaken by UDHC under the SLA, including procurement, financial management and safeguards policies; (b) guidance and quality control of the work and reports produced by UDHC; (c) reporting to the Bank on physical implementation, project performance indicators, procurement, financial management (including consolidated financial reports), and safeguards work; and (d) communicating with the Bank on project issues. It is composed of four units: Comprehensive Unit in charge of procurement, reporting, communication with the Bank, and general administrative issues; Project Unit in charge of social and environmental safeguards; Office of the Chief Engineer that provides assistance to the UDHC on technical / sector related issues; and Finance Unit with 10 full-time staff. 11. Project Implementation of Components A, B and C. The project will be implemented by UDHC, which has established a World Bank Project Group (WBPG) composed of four units (procurement, finance, engineering management, and operations) with 23 full-time staff borrowed from relevant departments within UDHC. WBPG‟s responsibilities include: (a) overall project implementation, i.e., procurement, contract management, social and environmental safeguards, loan (special account) disbursement requests to the Urumqi Finance Bureau, and fiduciary compliance; (b) coordinating with the two project executing entities (the SHN and UHN Divisions of UDHC) and with UITCPO; and (c) monitoring and reporting to the UITCPO on physical implementation, project performance indicators, procurement, financial management, and safeguards work. WBPG has hired two tendering companies, one per component, that will each assist with the procurement of components A and B. WBPG will manage the procurement of Component C. WBPG will also be responsible for safeguards

11 The document establishing the PLG with the names of the 29 government agencies is in the project files. 28 monitoring, with assistance from third-party monitoring consultants for social and environmental safeguards. 12. Operation of Physical Assets. UDHC has set up two divisions (SHN and UHN with respectively 51 and 120 full time staff) to operate and maintain project assets after construction. The Director of each division reports to a Deputy Director of UDHC, just under the General Manager. The organizational structure of these two divisions is the same and is presented below:

Financial Management

13. The financial management (FM) capacity assessment identified the following principal risk: project financial staff in UDHC do not have experience with Bank financed projects. Mitigation measures agreed include: (a) FM training plan to be prepared and all project financial staff to be trained before and during project implementation; and (b) a financial management manual (FMM) to be issued to standardize project FM procedures and provide guidance to project financial staff. FM risks, both pre and post-mitigation, have been assessed as “Moderate”. 14. Budgeting. UDHC will prepare an annual project implementation plan, including the funding resources and budget, which will have to be approved by their board of directors. The budget for counterpart funds has been committed by the local government. A budget variance analysis will be conducted semi-annually by UDHC and necessary actions will be taken to make sure that the project will be implemented as planned. Both the annual project plan and the budget variance analysis will be submitted to the PMO for review and comments. 15. Funds Flow. The Bank loan proceeds will flow from the Bank into a project Designated Account (DA) to be set up at and managed by the Xinjiang Uyghur Autonomous Region Finance Bureau (XRFB). XRFB will be directly responsible for the management, maintenance and reconciliation of DA activities. Supporting documents required for Bank disbursements will be prepared and submitted by UDHC through the PMO and the Municipal Finance Bureau (MFB) for review and verification before being sent to XRFB for disbursement processing. 16. Accounting and Financial Reporting. The administration, accounting and reporting of the project will be set up in accordance with Circular #13: “Accounting Regulations for World Bank Financed Projects” issued in January 2000 by the Ministry of Finance (MOF). The standard set of project financial statements has been agreed between the Bank and MOF. 17. The PMO will be responsible for overall project oversight, monitoring and coordination. UDHC will manage, monitor and maintain project accounting records. Original supporting

29 documents for project activities will be retained by UDHC. UDHC will work together with XRFB to prepare the project financial statements, which will then be submitted to the Bank through the PMO for review and comment on a regular basis. The unaudited semi-annual project interim financial reports (IFRs) (format in accordance with the aforementioned Circular #13 agreed with MOF) will be prepared and furnished to the Bank by the PMO no later than 45 days following each semester (the due dates will be August 15th and February 15th), in form and substance satisfactory to the Bank. 18. UDHC will utilize a computerized financial management information software, Yongyou, to record and maintain the project accounting books. The task team will monitor the accounting process, including the adequacy of this software, especially during the initial stage to ensure complete and accurate financial information is provided in a timely manner. 19. Internal Control. The related accounting policy, procedures and regulations were issued by MOF and an FMM will be prepared and issued to standardize and regularize the financial management and disbursement requirements related works. 20. Audit. The Xinjiang Uyghur Autonomous Region Audit Office (XRAO) has been identified as the auditor for the project. Annual audit reports will be issued by XRAO and will be due to the Bank within 6 months after the end of each calendar year.

Disbursements

21. Four disbursement methods are all available for the project: advance, reimbursement, direct payment and special commitment. Supporting documents required for Bank disbursement under different disbursement methods will be documented in the Disbursement Letter issued by the Bank. 22. One DA in US dollars will be opened at a commercial bank acceptable to the Bank and will be managed by XRFB. The ceiling of the DA will be determined and documented in the Disbursement Letter. 23. The Bank loan would be disbursed against eligible expenditures (taxes inclusive) as shown in the following table. Category description Amount allocated Percentage (US$) Civil Works and Goods (including Supply 99,020,000 100 and Installation) Consulting services, training, and study 730,000 100 tours, and workshops Front-end fee 250,000 100 Premium on Interest Rate Cap or Interest 0 rate Collar Total 100,000,000

24. Retroactive financing of 30 US$ million will apply for this project for eligible expenditures commencing February 1, 2011 and is specified in the loan agreement.

30

Procurement

25. The procurement capacity assessment identified the following principal risk: The procurement staff in UDHC does not have experience with Bank financed projects. Mitigation measures include: (a) procurement training has been provided during project preparation, and procurement staff will be further trained before and during project implementation; (b) a procurement manual (PM) has been issued to standardize project procurement procedures and provide guidance to project procurement staff; and (c) two national-level procurement agents with experience in World Bank procurement have been hired by UDHC to assist with procurement activities. The overall risk for procurement is considered “Moderate”. 26. UDHC will be responsible for the procurement of all project contracts. Procurement will be carried out in accordance with the “Guidelines: Procurement under IBRD Loans and IDA Credits” dated May 2004, revised in October 2006 and in May 2010, and the “Guidelines: Selection and Employment of Consultants by World Bank Borrowers” dated May 2004, revised in October 2006 and in May 2010; and the provisions stipulated in the Loan Agreement. NCB shall be carried out in accordance with the Law on Tendering and Bidding of the People’s Republic of China promulgated by Order of the President of the People‟s Republic of China on August 30, 1999 subject to the modifications stipulated in the Legal Agreement in order to ensure broad consistency with the Bank‟s Procurement Guidelines. 27. Procurement of Works. Works procured under this project will include construction and installation of heat-exchange facilities and stations, heat network pipelines, pressure isolation stations, monitoring center, etc. Procurement will be done using the Bank‟s Standard Bidding Documents (SBD) for all International Competitive Bidding (ICB) and National MBD (Model Bidding Documents) agreed with or satisfactory to the Bank for all National Competitive Bidding. 28. Procurement of Goods. Goods procured under this project will include equipment and material for pressure stations, preset direct-buried insulation network pipelines and materials (valves and compensators, etc.), metering, detecting devices, vehicles, office automation equipment, etc. Procurement will be done using the Bank‟s SBD for all ICB and National MBD agreed with or satisfactory to the Bank for all National Competitive Bidding. 29. Selection of Consultants. Consulting services are included in Component C (TA4). Short lists of consultants (firms) for services estimated to cost less than US$300,000 equivalent per contract may be composed entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. The short lists should normally be composed of firms of similar experience acting in the same field of expertise. If mixing is used, the selection should be made using Quality Based Selection or Selection Based on the Consultants‟ Qualifications (CQS) for small assignments. 30. Procurement Plan. The initial 18-month procurement plan for the project, prepared by UDHC, has been reviewed by the Bank finalized. Contracts for retroactive financing are listed in the Procurement Plan. It will also be available in the Project‟s database and on the Bank‟s external website. The procurement plan will be updated in agreement with the Bank annually, or as required, to reflect project implementation needs and improvements in institutional capacity. 31. Frequency of Procurement Supervision. In addition to the prior-review supervision missions carried out from Bank offices, Bank procurement supervision missions will visit the

31

field to carry out post-review of procurement activities every 12 months. The post review sampling ratio will be one out of five contracts. 32. Prior-Review Thresholds. The prior-review thresholds are indicated in the table below. Procurement Thresholds

Prior Review Thresholds Procurement/Selection Method Thresholds (US$ million) (US$ million) Least ICB NCB Shopping QCBS QBS CQS SSS Cost Goods 0.5 ≥1.0 <1.0 <0.1 Works, 5.0 ≥20 <20 <0.2 including Supply and Installation Consulting 0.2 for firm -- -- <0.2 -- -- Services 0.05 for individuals SSS: all -- No Threshold

33. Tables below list goods, civil works, and consulting contracts subject to international competition over the first 18 months.

ICB Goods Contracts

Review Procure Domestic Advance Ref. No. Description by Bank ment Preference Contracting (Prior / Method (Yes/No) (Yes/No)* Post) SGG1 Supply of Pre-insulated Pipelines ICB Yes Prior Yes and Materials for SHN in 2011 SGG2 Supply of Pre-insulated Pipelines ICB Yes Prior No and Materials for SHN in 2012 UGMG1 Supply of Main Pre-insulated Pipelines and Materials for UHN in ICB Yes Prior Yes 2011 UGBG1 Supply of Branch Pre-insulated Pipelines and Materials for UHN in ICB Yes Prior Yes 2011 UGG2 Supply of –Pre-insulated Pipelines ICB Yes Prior No and Materials for UHN in 2012

32

QCBS Consulting Packages

Review Description Ref. Selection by Bank of No. Method (Prior / Assignment Post) Heating Networks Operation TA4 QCBS prior with Multi- Sources Study

Environment

34. The project is expected to have net positive environmental benefits by replacing the use of small heating boilers with district heating supplied by CHP plants with advanced emissions control. However, there will be temporary moderate environmental impacts during the construction phase, such as noise, dust, solid waste disposal, worker safety, social and traffic disturbance, and chance finding of cultural relics. There are standard and well coded measures to mitigate typical impacts caused by construction which have been described in both EA and EMPs. The key issue is to ensure their effective implementation, which is addressed in the EMPs. 35. Large portions of the pipelines will pass through roads with substantial traffic volumes and densely populated areas. During construction of parts of the proposed networks in 2010, pipeline construction was planned carefully and carried out rapidly thus minimizing social disturbances (disruption of daily activities, traffic impacts and reduced accessibility). Good practices and experience from the 2010 construction program were incorporated in the EMP. The EMP also includes several management plans developed during the social analysis process to address principal social impacts. 36. Environmental Management Plans (EMP). The EMPs outline the institutional arrangements and responsibilities of all parties (PMO, project owner, contractors, supervision engineers, operators, government agencies, etc) for its implementation. The PMO will have at least one staff in charge of EMP implementation, supervision and reporting. 37. The EMPs specify the mitigation measures needed to address the adverse impacts during preparation, construction and operation, based on past experience and recommendations from the due diligence review of the 2010 construction program and social analysis reports (e.g., traffic management plan) of the project. The EMPs detail the environmental monitoring arrangements for the construction and operation phases. They specify the parameters to be monitored, the method, location, frequency, monitoring agency, and budget estimate. Environmental monitoring has been integrated and budgeted into the overall M&E program of the project. 38. To ensure the effective implementation of the EMP, a budgeted training plan has been developed, introducing the training programs and arrangements for all parties involved (PMO

33 staff, project owners, contractors, workers, supervision engineers, etc). Its cost is included in the overall implementation and training plan of the project. 39. Supervising and reporting mechanisms are included in the EMP. Supervision engineers will be primarily responsible for daily supervision of EMP measures during construction. They will record performance in their monthly supervision report to the project owner and the PMO. The PMO, assisted by environmental experts, will carry out random inspection. During the operation phase, implementation of the EMP will be the responsibility of operators, overseen by the PMO and local environmental authorities. The EMP will be included in the bidding documents and contracts with contractors and engineering supervisors to ensure implementation. 40. Boiler Closures. Boilers that are to be replaced by the project will no longer be used, except for a few that will be held in reserve for emergencies. The closure of the boilers constitutes indirect impacts induced by the project. The municipality prepared a plan on boiler closure that shall be monitored by the project.

41. Since the boilers belong to different owners and are beyond the control of the project, the timing of the demolition is uncertain. Nevertheless, the municipality developed a list of all small boilers to be closed, which includes: an inventory about their location, size, age, and whether they contain asbestos as insulation; the institutional arrangements and responsibilities; and procedures and mitigation measures for proper demolition, handling of wastes especially asbestos, and site clean-up. 42. The demolition plan has been included in the EMP, although its implementation will be the responsibility of the boilers‟ owners for those not owned by the project entity. Supervision and monitoring will largely rest on Urumqi government and local Environmental Protection Bureaus at both city and district level. A leaflet about hazards of asbestos and methods for proper demolition and handling of asbestos was developed by the PMO and will be distributed to all concerned small boiler houses and future demolishers. 43. Associated facilities. Two existing CHP plants and three peak load boiler houses will supply heat to the project areas. The EA team conducted a due diligence review of environmental performance of the CHPs and the Heat-Only Boilers (HOBs) with regard to air emission control, wastewater and solid waste, as these are the major and long-term impacts from the CHPs and the HOBs. For Component A (Shuimogou district network), the Huadian (Weihuliang III) CHP plant has been in operation since November 2009 and is using electrostatic precipitators (ESP) for removal of dust and wet lime scrubbing for flue gas desulfurization. Its on-line monitoring system shows that flue gas emissions have been compliant with national and local emission standards as well as with the WB/IFC Environmental Health and Safety (EHS) guidelines. For Component B (Shayibake district network), the Hongyanchi CHP plant, partly commissioned since September 2010, uses the same type of boilers and technology for de- dusting and desulfurization as Huadian CHP. It also has on-line, continuous flue gas monitoring system, the data from which indicate that flue gas emissions have been in compliance with all applicable standards mentioned earlier. 44. Three existing large HOB houses, which serve as peak load boilers for the two networks. All these HOBs are coal-fired with water scrubbing and ESP for de-dusting and alkali for desulfurization. Due to lower removal efficiency, they cannot meet emission standards. The Urumqi Municipal Government required large HOBs to comply with the latest local emission

34 standards on SO2 and dust from September 15, 2010, mandating a removal efficiency of no less than 99% for ESPs and no less than 80% for desulphurization. Boilers at the three HOBs were retrofitted to meet the new local pollution standards with semi-dry lime or double alkali desulphurization and enhanced scrubbing or ESP for dust removal. Monitoring data showed that they meet the latest local standard for flue gas emissions which is stricter than the national standard for coal-fired HOBs and comparable to those of the WB/IFC‟s EHS guidelines. 45. Most slag and ashes from coal combustion and wastes from desulphurization in these facilities are used as raw materials for the production of building materials, as they are classified as industrial wastes in Chain and thus can be utilized. Residues are disposed in municipal landfills together with domestic wastes. Wastewater is treated first on-site according to domestic requirements and eventually in municipal wastewater treatment plants. Wastewater from these facilities meets domestic discharge standards into municipal sewer systems. 46. Alternative Analysis. Different alternatives were identified and analyzed during the EA process to avoid or minimize potential adverse environmental and social impacts. A “without project” scenario was also considered as an alternative to each sub-project. Since the project will replace small heat boilers with district heating supplied by CHP plants equipped with advanced emission control devices, a net positive environmental benefit is anticipated when compared to the without project scenario. 47. Alternatives analyzed for both sub-projects include: (a) locations for pressurized stations and substations; (b) routings for pipelines and different construction methods; (c) different types of heat sources, namely individual heating from small boilers, district heating with large-scale coal-fired boiler houses or with CHP, with the latter option recommended primarily for environmental considerations; and (d) different fuel used for heat supply, i.e., coal and natural gas. Though natural gas could be preferred for environmental considerations, coal-fired CHP is the option chosen by UMG because of energy supply security concerns and cost of natural gas in the region. 48. Public Consultation and Information Disclosure. Two rounds of Information Disclosure were undertaken. The first round took place during the EA preparation and investigation. The second round was carried out after the draft EA was made available. Information about the project and public access to the draft EA (location and time) was disclosed in the major local newspapers, official and popular websites, and bulletin-boards in local communities. The EA and the Executive Summary were posted on the World Bank Infoshop. The table below summarizes the EA disclosure activities.

Round Information disclosed Location Time 1st Announcement of EA for Project neighborhoods, schools Jan 27-Feb 28, UDHP and solicitation of etc; 2010 public opinion Urumqi EPB‟s website: http://www.wlmqhb.gov.cn; Xinjiang popular website (new March 2-12, 2010 silk road): http://www.xj163.cn; Urumqi Evening (newspaper) March 2, 2010 2nd Announcement of public Urumqi EPB‟s website: 8-18 April 2010 access and consultation for http://www.wlmqhb.gov.cn;

35

draft EA of UDHP with Xinjiang popular website (new From 8 April 2010 links to EA drafts; silk road): http://www.xj163.cn; Urumqi Evening (newspaper); 21 April 2010 Hardcopy of EA drafts Office of the PMO and Urumqi From 21 April EPB 2010

49. Two rounds of public consultation were undertaken following information disclosure. These consultations took various forms, mainly questionnaires, interviews and meetings with the public and experts. The majority of those consulted expressed strong support for the project which they believe will alleviate air pollution in Urumqi. Major concerns raised include: dust and noise, disturbance of traffic, business and religious activities during construction, and quality of heat supply during operation. The EA provided feedback and countermeasures to address these concerns.

Social

50. Project design has avoided land acquisition and involuntary resettlement. A resettlement policy framework has been prepared to address any land acquisition and resettlement that may be required due to changes in project design during implementation. The Bank-financed pipelines will dispatch heat from two existing plants and be connected to the main heating network financed and installed by Urumqi in 2010. The two plants were built more than 10 years ago and their expansions were completed respectively in 2008 and 2010 on company-owned lands without involving any resettlement activities. Small scale resettlement activities occurred for the installation of the main heating network financed by Urumqi in 2010, e.g., construction of a heat pressure regulation substation on municipal land in hilly terrain and pipeline installation requiring compensation for state enterprise trees. These small scale resettlement activities and practices were in compliance with Bank policies. 51. A social analysis conducted for the project identified project stakeholders: citizens, religious people, shop keepers, communities, schools, hospitals, local markets, mosques, heating companies (including leaders, administrative staff, and workers), municipal departments in charge of traffic management, and the PMO. 1,106 questionnaires were received from citizens, 411 questionnaires were collected from workers, 192 private interviews were conducted, and 5 focus group discussions were completed, involving different participants (both Chinese and minorities, male and female, etc) in the project areas. 52. Urumqi has more than 50 different Chinese ethnic minorities or groups: (Uygurs, Han, Kazaks, Kirgiz, Mongols, etc) totaling 637,000 people – 27% of its population. 75% of them live in the inner-city area and the rest in peri-urban areas. Most of these persons have immigrated to Urumqi since 1951. The characteristics of indigenous peoples described in the Bank‟s OP 4.10 – Indigenous Peoples – are not found in the project area. In particular, they are not considered to have collective attachment to ancestral territories in the project area nor has there been forced severance from these ancestral lands. This policy is therefore not triggered. 53. Participatory Approach. The project information was advertised in the main local newspapers and hotlines for information disclosure were opened. Through broad participation of project stakeholders, public consultations, interviews, focus group discussions, and substantial data gathering and analysis, the social analysis prioritized stakeholders‟ concerns and concluded

36 that the communities fully supported the project. Their concerns focused on three major issues: traffic disturbance during construction; workers affected by the small boilers closure program; and the impact of heat pricing on low-income families. Based on the social analysis, the PMO prepared the following documents: traffic management plan; emergency management plan (i.e., in case an electrical line was cut during pipeline installation); monitoring plan for the municipality‟s policy to re-employ workers affected by the small boilers closure program, and monitoring plan for the UMG policy to protect low-income families from the impact of unexpected increases in heat prices. The local social team, communities, and workers affected by the small boilers closure program will participate in the monitoring process and public consultations are expected to continue. 54. Institutional Arrangements. Institutional arrangements for the four separate management plans (i.e., monitoring plan of heat pricing on low-income families, monitoring plan for workers affected by the small boilers closure program, traffic management plan, and emergency management plan) are detailed in these documents and have been incorporated into the EMP. A qualified independent institution will be contracted to serve as the independent monitoring agency. Monitoring results will be regularly reported twice a year and, if needed, remedial actions will be designed.

Monitoring & Evaluation

55. Annex 1 lists the PDO level results indicators for the project, as well as the intermediate results indicators for each component. UDHC will be responsible for the implementation of monitoring plans, meter calibration, and preparation and submission of periodic monitoring reports to UPMO, including inputs to the semi-annual project progress reports and annual reports on compliance with performance indicators and covenants. It will also be required to report on its business plan and financial performance. Based on inputs from UDHC, UPMO will evaluate interim results and ensure corrective actions are taken as necessary. UPMO will also be responsible for submitting these reports to the Bank. 56. UDHC will collect four data sets needed for monitoring key performance indicators:  Coal consumption by the CHP plant under combined heat and power production conditions, and by peak load boiler plants.  Heat supplied by the CHP plant, peak load boiler plants, and the various substations under combined heat and power production conditions.  Power supplied by the CHP plant under combined heat and power production conditions.  Pollutant emission of SO2 and dust from the CHP plant under combined heat and power production conditions and emission of the peak load boiler plants. 57. Key results will be measured by the methodology and the indicators given below. 58. Energy efficiency performance indicators: Reduced standard coal consumption for heating per connected floor area. The baseline scenario was identified as the continuous use of separated boilers for heating and the construction of new boilers to meet the increasing heat

37 demand.12 Buildings were categorized into existing and new buildings: existing buildings are those supplied by a substation that was connected to existing boilers before the start of the project; new buildings are those supplied by a substation that will be constructed after the start of the project. 59. As all boilers use coal, no further categorization was made on the fuel type to determine baseline boiler efficiency. However, because of the size and technology, the efficiency of boilers used in the baseline varies. For conservative estimates of baseline values, 65% 13 and 85%14 boiler efficiencies were adopted respectively for existing and new areas. The type of coal used by CHP and the boilers is the same, and key technical parameters, i.e., lower heat value, sulfur and dust contents are pre-determined based on a testing report submitted by the UMG. 60. Environmental performance indicators. These indicators used are:  Reduced dust annual boiler plant emissions per connected floor area 15  Reduced SO2 annual boiler plant emissions per connected floor area 16  Reduced CO2 annual boiler plant emissions per connected floor area

12 Following the "Combined tool to identify the baseline and demonstrate additionality", adopted in the methodology AM0058/Version 03.1. 13 According to the boiler efficiency survey conducted by the Safety and Science Institute of Liaoning Province in 2009, the boiler efficiencies in different categories are: Capacity Efficiency D ≤2.8 MW 49.32% 2.8MW

14 AM0058: Table 2: Default baseline efficiencies for different heat supply technologies: State-of-the-art boiler 100% New natural gas fired boiler (w/o condenser) 92% New oil fired boiler 90% Old natural gas fired boiler (w/o condenser) 87% New coal fired boiler 85% Old oil fired boiler 85% Old coal fired boiler 80% 15 According to the design, desulphurization and dust collection efficiencies will increase from 15% to 90% and from 82% to 99% after environmental upgrading measures for peak load boilers. 16 Referring to the default value of the Intergovernmental Panel on Climate Change (IPCC) 2006, one ton of standard coal can be converted to 2.78 tons of CO2. 38

Annex 4 Operational Risk Assessment Framework (ORAF)

Project Development Objective(s)

The proposed project development objective (PDO) is to connect consumers in selected districts of Urumqi City to district heating services with improved energy efficient and environmental performance.

Key Results Indicators: 1. Reduced annual boiler plant coal consumption for heating per connected floor area.

2. Reduced SO2 annual boiler plant emissions per connected floor area. 3. Reduced dust annual boiler plant emissions per connected floor area.

4. Reduced CO2 annual boiler plant emissions per connected floor area.

Risk Category Risk Rating Risk Description Proposed Mitigation Measures

Project Stakeholder Risks H Local Authority commitment may be unsustained. Urumqi is on a central government priority list for air pollution reduction initiatives. UMG is closely

monitored by the Autonomous Region government on progress toward reducing air pollution. Commercial agreements in place are a major improvement over prevailing Chinese contractual arrangements in the heating sector.

Managing new commercial relationships and UMG issued a circular that provides a framework and willingness to connect to new network. basis for its boiler closure program. Options offered to small boiler suppliers, including sale of the business, conversion to distribution companies (DISCOs) and purchase heat from the new network, closure of unlicensed boilers with right to keep land with changed zoning. Based on the 2010 experience, the process has moved forward efficiently.

39

Unexpected rise in heat price creates concerns among UMG has a policy to protect families under the poverty low income households. line from unexpected increases in input costs. This will be monitored during implementation.

Implementing Agency Risks MI The PMO and the Implementation Agency may lack A well staffed project management structure is in place. adequate processes and/or systems sufficient to allow Financial staff will be trained before implementation for successful achievement of results envisaged by and refresher training will be provided during the project. implementation. FM manuals have been prepared to standardize project FM procedures and provide guidance to financial staff. Procurement training has been provided to all procurement staff, and refresher training will be provided during project implementation. A procurement manual (PM) will be issued to procurement staff. Two national-level procurement agents with experience in World Bank procurement hired by UDHC will assist with procurement activities.

The lead Implementation Agency may lack UPMO and the Construction Commission have ownership, appropriate decision making, demonstrated high ownership during project accountability in its management system required to preparation. The project will be supervised regularly achieve project outputs. during implementation.

The Implementation Agency will award contracts on Procurement will be subject to prior and post review a non competitive basis. based on country level thresholds; financial management and technical progress will be supervised regularly during implementation.

Project Risks  Design MI Technical designs will not achieve desired outputs. Feasibility studies include a hydraulic analysis which Pilot building level substations require coordination identified locations for pressure isolations stations to between the Urumqi Construction Commission and hydraulically separate the primary and secondary real estate developers. networks and to regulate pressure differences. DH network control and operation strategy for safety have been considered in system design. An emergency heat supply plan.

40

UDHC has in place adequate staffing with experience in large scale physical investments.

Bid documents, such as for building level substations, will be reviewed for clarity by the Bank team as part of routine procurement review and supervision.

 Social and Environmental MI Resettlement Policy Framework and Environmental An RPF and EMP have been adopted. The EMP will be Management Plan are not carried out satisfactorily. included in bid documents. Adequate safeguards staff will be included in the municipality project office and UDHC. The Bank will supervise implementation of safeguards on a regular basis. NA  Program and Donor

 Delivery Quality MI Heat demand, revenue collection, and prices fall short Financial covenants are closely linked to the liquidity of predictions and affect revenues and delay and cash flow performance of the company. The Bank implementation. will supervise compliance with covenants on a regular basis.

Feasibility reviews have shown that the projected demand is in line with the recent pace of residential construction in Urumqi.

Monitoring data will not be provided for outcome KPIs are linked to the environmental, efficiency and indicators. financial performance of the system. Emissions data will be collected from Continuous Emission Monitoring systems installed in the CHPs and HOBs. The Bank will supervise adequate reporting of KPIs on a regular basis.

Overall Risk Rating at Overall Risk Rating During Comments Preparation Implementation MI MI The overall risk rating for preparation and implementation risks is MI.

Legend: MI – Low Likelihood, High Impact H – High Likelihood, High Impact

41

Annex 5: Implementation Support Plan

Implementation Strategy

1. The strategy for implementation support has been developed based on the nature and risk profile of the proposed project. It will aim at making implementation support to the client more flexible and efficient, and will focus on the implementation of risk mitigation measures defined in the ORAF: stakeholder risks, rated as high; and implementing agency risk and project specific risks, which are rated medium impact. 2. Stakeholder risks. Bank missions will confirm that the Environmental Management Plan and plans for boiler closure and traffic management are carried out by the responsible stakeholders. Third party monitoring reports will enhance supervision. Bank missions will also review financial performance of UDHC to monitor performance of new commercial agreements put in place to purchase and sell heating. The environment specialist and the social safeguards specialist will ensure that the EMP and RPF are followed consistently through reviews of monitoring reports, regular dialogue with the municipal and UDHC project office, and site visits. 3. Implementing agency risks. Bank missions will confirm that the municipal project office and UDHC are fully staffed with qualified specialists, and that appropriate training is provided to them, including refresher training when required. Bank FM and procurement specialists will provide necessary training to relevant project staff. They will review project reports as part of their supervision function, maintain contact with project staff, and conduct site visits to perform their implementation support function. 4. Technical specialists will confirm that UDHC maintains adequate staff in place for contract management and system operations. They will also review the work of consultants supporting UDHC in optimizing network operation. Together with the Task Team Leader, the technical specialists will monitor performance through the Key Performance Indicators on environmental performance and energy efficiency of district heating services. The KPIs also include a financial performance indicator on the adequacy of cash flow for UDHC operations. Together, the KPI reviews will be the focus of dialogue on sustainability issues. 5. Use of Country Office-Based Staff. In order to ensure that the mitigation measures for the risks are being implemented efficiently and effectively, the task team will include a substantial Beijing-based staff, including the Task Team Leader, environmental safeguards, social safeguards, FM and procurement specialists. The Task Team Leader will maintain regular contact with key officials of the municipality and UDHC to exchange views on strategic issues of project implementation and address any critical issues, e.g., potential or actual non- compliance with important project covenants. Staffing and resources will be reviewed from time to time as is standard Bank practice.

42

6. Table below indicates the focus areas and skill needs required to provide implementation support during the initial and subsequent periods of the project. Resource Estimate Partner Time Focus (in Staff Weeks) Role First Team leadership Task Team Leader 4 NA twelve Technical supervision of: (a) bidding DH Specialist/Engineer months documents; (b) the development and 4 implementation of the Technical Assistance Component Client interaction and on-the-ground Country-office based project coordination on technical Energy Specialist 4 aspects Support to the team with the Operations Officer preparation of project documents and 4 missions Procurement: (a) review of bidding Procurement Specialist documents; and (b) delivery of training 3 FM training and supervision FM Specialist 1 Environmental supervision Environmental 2 Specialist Social supervision Social Specialist 2 Review of the Urumqi District Heating Financial Analyst Company‟s financial status 1 12-48 Team leadership Task Team Leader 3 NA months Review of project construction and DH Specialist/Engineer 3 implementation of the Technical Country-office based 3 Assistance Component Energy Specialist Procurement Specialist 3 Support to the team with the Operations Officer preparation of project documents and 3 missions Financial management, disbursement FM Specialist 1 and reporting Environment and social monitoring & Environmental reporting Specialist 2 Social Specialist 2 Review of the Urumqi Heating Financial Analyst Company‟s financial status 1

43

7. Table below indicates the staffing needs for implementation support.

Number of Number of Staff Weeks Trips Skills Needed Comments (SWs) (per Fiscal Year) Task Team Leader 4 SWs during the first Two Country office based year, then 3 SWs annually in the following years DH Specialist/ 4 SWs during the first Two International staff Engineer year, then 3 SWs annually (Washington based) in the following years Country-office based 4 SWs during the first Two Country office based Energy Specialist year, then 3 SWs annually in the following years Operations Officer 4 SWs during the first Two International staff year, then 3 SWs annually (Washington based) in the following years Procurement 3 SWs annually Fields trips as Country office based Specialist required FM Specialist 1 SW annually Fields trips as Country office based required Environmental 2 SWs annually Fields trips as Country office based Specialist required Social Specialist 2 SWs annually Fields trips as Country office based required Financial Analyst 1 SW annually One International staff (Washington based)

44

Annex 6: Team Composition

World Bank staff and consultants who worked on the project

Name Title Unit Gailius Draugelis Senior Energy Specialist (Task Team EASCS Leader) Pekka Salminen Senior Energy Specialist (DH ECSS2 Engineer) Yanqin Song Energy Specialist (Institutional EASCS Arrangements) Emmanuel Py Infrastructure Specialist (Operations) EASIN Zhuo Cheng Carbon Finance Analyst EASCS Xin Ren Environment Specialist EASCS Zhefu Liu Senior Social Development Specialist EASCS Yuan Wang Procurement Analyst EAPPR Fang Zhang Financial Management Analyst EAPFM Lu Zeng Program Assistant (Financial) EASCS Kun Cao Team Assistant EACCF Cristina Hernandez Program Assistant EASIN Kishore Nadkarni Consultant, Financial Analyst EASCS Dianjun Zhang Consultant, DH Engineer EASCS Yongli Wang Consultant, Environmental Safeguards EASCS

45

Annex 7: Economic and Financial Analysis

1. The Annex provides details on the economic and financial appraisal of the proposed project and the analysis of the current as well as the projected financial performance of UDHC. 2. Key assumptions. The economic appraisal of the project relies on the following key assumptions: Key assumption of economic appraisal

Item Value Notes Coal price for CHPs 90 RMB/ton Current prices in Urumqi Coal price for HOBs 120 RMB/ton region. Lower heating value of coal 22,337 kJ/kg Lower heating value of standard coal 29,300 kJ/kg Boiler efficiency of small existing Based on experimental 65% boilers measurements in China for Boiler efficiency of large existing different boiler 75% boilers capacities/types. Boiler efficiency of new boilers 85% CHP heating efficiency 90% Transmission network loss 8% Consultant and Bank team Distribution heat loss 11% joint estimates Heat loss of existing large networks 22% Heat loss of existing small networks 20% O&M of new investments 1% of investments Bank team estimates O&M and repair of existing heating 5% of investments systems Value of SO2 emission reduction 1,301 RMB/ton Based on Benefit Transfer Value of dust emission reduction 5,609 RMB/ton Method of New York Externality Model (Rowe and Value of CO2 emission reduction 94 RMB/ton others 1994) used also in Liaoning PAD, 2008. VAT rate 13% Assessment period 20 years Discount rate 10%

3. This project is about changing the way apartments are heated before, using dispersed large and small inefficient and polluting boilers, connecting them to CHP-based district heating networks. This new system connects consumers to district heating systems with improved energy efficiency and environmental performance, resulting in coal savings and reduction of pollution compared to the baseline. The economic analysis of the project compares the with-project and without-project alternatives, taking into account all comparable costs of the two. The project alternative includes: (a) base load from coal-fired CHPs and peak load from coal-fired HOBs; and (b) construction of the heat transmission and distribution system as in the project description.

46

The without-project alternative includes: (a) the continuation of existing heating methods based on local coal-fired boilers, and (b) new coal-fired boilers for new building areas. Economic costs and benefits of the project were calculated exclusive of taxes and subsidies. The economic analysis is conservative, especially with respect to the connection of new buildings, because the new areas are assumed to be heated by efficient modern boilers in the baseline (without-project) alternative.

Economic Analysis

4. Major benefits were estimated by taking into account the following: (a) fuel efficiency improvements generated by replacing local, inefficient coal-fired boilers by heat supply from the CHP plants, taking into account the poor efficiency of small and large local boilers; (b) reduced heat losses generated by improving existing substation17 ; This benefit takes into account the reduced heat loss because of modernization and automation of the substations. 18 (c) operation, maintenance and repair costs variances for both alternatives; and (d) environmental benefits of reduced dust, SO2 and CO2 emissions as a result of the project. 5. The economic analysis results in an economic internal rate of return (EIRR) of 21.3% for project investments with the environmental benefits. Subprojects for UHN and SHN networks have EIRRs of 15.7% and 26.5% respectively.

Estimated Total Annual Coal Consumption and Total Average Efficiency by end of Project

Urumqi District Heating Project: Estimated Total Annual Coal Consumption at End of Implementation (000 tce) 1,000 900 800 700 600 Total Efficiency Total Efficiency 500 58% 72% 400 300 200 100 0 Baseline Project

6. Sensitivity Analysis: Sensitivity analysis was conducted for three scenarios: (a) 20 percent increase in investment costs; (b) 20 percent decrease in total economic benefits; and (c) no

17 Estimates took into account experience from similar projects in China and in Europe 18 Water losses of the substation were not measured and reduction of water losses was not taken into account as those were estimated to have minor impact on the economic indicators. 47 environmental benefits. Results of the sensitivity analysis indicate that under all of the above scenarios, the project remains economically viable; see table below.

Sensitivity analysis for economic appraisal + 20% - 20% No Base case investment economic environmental cost benefits benefits Whole Project 21.3 15.3 19.1 11.7 UHN-network 15.7 10.0 13.7 8.2 SHN-network 26.5 20.5 24.1 11.7

Financial Analysis

7. UDHC’s Past and Current Financial Performance. UDHC was established in 1984 as a municipally-owned company to provide district heating services. Its current operations include three divisions: (a) Weidian/Peakload Boiler; (b) Nan Qu (South); and (c) Pulverized Coal Fired Boiler (PCFB). UDHC currently sells heat mainly to retail customers, with a smaller part sold as bulk sales to other companies. In addition to heat produced in its own boilers, UDHC purchases heat from CHPs: heat purchases account for about 52% of UDHC operating expenses. 8. Heat sales and purchase tariffs. Heat sales and purchase tariffs are set by UMG. Heat sales tariffs include a VAT of 13% and are currently the same (RMB 22/m 2) for both residential and non-residential customers. Heat sales tariffs have remained at this level for some years, reflecting UMG‟s concern with the impact of increased prices, particularly on residential customers. Heat purchase prices have increased gradually in the past, based on changes in fuel (mainly coal) prices. In 2010, in view of the planned major expansion in UDHC‟s investment program and operations, UMG reduced the heat purchase price from CHPs from 15 RMB/GJ to RMB11.5/GJ, inclusive of a VAT of 13%. 9. UDHC’s financial performance. UDHC‟s financial statements for the period 2007 to 2009 cover the Weidian/Peakload and the PCFB divisions but not Nan Qu (South). Construction of the facilities for the Nan Qu division is still on-going, and the assets/liabilities and revenues/expenses have not yet been consolidated in UDHC‟s accounts. Based on unaudited financial statements, key financial indicators are summarized below:

UDHC – Selected Financial indicators Unit 2007 2008 2009

Billed revenues RMB million 97.9 109.1 118 Collected revenues RMB million 89 99.3 106.2 Cash operating RMB million 52.9 66.6 65.8 expenses Total operating RMB million 78.9 93.3 92.7 expenses Net income after tax RMB million 5.7 6.5 7.7 Current assets RMB million 181.7 235.4 241.5

48

Unit 2007 2008 2009

Current liabilities RMB million 53.1 87.6 100.3 Ratios:

Collection ratio % 91 91 90 Working ratio % 59 67 62 Current ratio ratio 3.4 2.7 2.4

10. UDHC’s Planned Investment Program (2010 to 2015). UDHC is undertaking a major investment program in the period 2010 to 2015, which will substantially increase its operations. In addition to the SHN and UHN components that will be financed under the proposed Bank loan, UDHC has other major investments in its Nan Qu and Midong divisions. Key details of UDHC‟s overall investment program are provided below.

UDHC’s Planned Investment Program (2010 to 2015) Debt Implemen- Investment Retail Sales Bulk Heat Financing Component tation Cost (RMB Area Sales (RMB Period million) (million m2) (MWh) million) Nan Qu (South) 2009-2011 110 60 10.00 SHN 2010-2012 952 822 5.79 1,531,593 (Shayibake) UHN (Urumqi 2010-2014 1,293 1,084 9.08 927,573 Weidian III) Midong 2010-2014 517 252 6.03 843,228 Total UDHC 3,548 2,218 30.90 3,302,414

11. UDHC’s Projected Financial Performance. During the project implementation period, UDHC‟s operations will expand very substantially as a result of its overall investment program discussed above. UDHC‟s annual retail heat sales area served will increase from the current 19 million m2 to 38 million m2 in 2015, and its bulk heat sales will increase by six times - from 512,687 MWh to 3,373,360 MWh. Projections of UDHC‟s financial situation have been prepared on a consolidated basis, taking the overall investment program into account. The detailed analysis and projections, including projected income statements, balance sheets, cash flow statements and results of sensitivity analysis are kept in the Project Files, and a summary of the results is reported in the table on Key Financial Indicators in Attachment 1 to this Annex. 12. The key assumptions are:  Heat demand (residential and non-residential) will develop substantially as projected; the assessment indicates that the projected demand is in line with the recent pace of housing development in Urumqi.  The retail heat sales tariff (including VAT) will be maintained at a level not less than 22 RMB/m2 and UDHC will be allowed to retain the VAT collected from residential customers as at present; however, the required levels of heat sales tariff are sensitive to

49

heat purchase prices, and any increases in heat purchase prices will need to be compensated with appropriate increases in heat sales tariffs.  The bulk heat sales tariff to distribution companies (DISCOs) will be at a level not less than RMB19/GJ (including VAT), and UDHC will be allowed to retain the portion of VAT collected from DISCO‟s residential customers.  Heat purchase price from CHPs will not be higher than RMB11.5/GJ (including VAT) as at present and the heat purchase price from peakload boilers (PLBs) will not be higher than 22 RMB/GJ (including VAT).  UDHC‟s heat supply contracts with DISCOs and the heat purchase contracts with CHPs and PLBs will be signed in a timely manner.  UDHC will maintain its annual revenue collection ratio (collected revenues/billed revenues) at a level not less than 90% and achieve gradual annual improvements (indicated in Attachment 2).  UMG will timely transfer to UDHC each year the connection fees indicated in UDHC‟s Investment Cost and Financing Program. 13. Sensitivity of heat sales prices to heat purchase prices. Heat purchase expenses account for about 52% of UDHC‟s operating expenses. The current level of RMB22 /m2, if maintained in real terms, is adequate for UDHC to meet its financial obligations and comply with the covenanted financial ratios during the project implementation period. 14. The required levels of heat sales prices are sensitive to heat purchase costs. The level of RMB22 /m2 is based on maintenance of a heat purchase price of RMB11.5 /GJ from CHPs (both prices in real terms). Any increase in heat purchase prices would need to be compensated by adequate increases in UDHC‟s heat sales prices. Thus, a 10% increase in the heat purchase price would require a 4% increase in the heat sales price, if UDHC is to meet the covenanted financial ratios (working ratio and current ratio) during project implementation. 15. Coal purchased by the CHPs is mainly from captive mines. The likelihood of coal prices in Urumqi rising to reach levels in Eastern China is low due to the relatively long transport distances compared to alternative sources and lack of transport capacity. Mine-mouth prices near Urumqi are around RMB45 to 160 per tonne for various coal qualities, as compared to a price of about RMB950-1,600 per tonne for delivered Xinjiang coal to Eastern depots. 16. In the event that heat purchase prices are increased, the Government has an obligation, under the Loan Agreement, to take all necessary actions, including adjustment of UDHC‟s sales tariffs, to enable UDHC to meet its financial obligations under the project. 17. Major financial risks in regard to the above and the planned mitigating measures are discussed in the Section V in the Main Text of the PAD. 18. Results. The projections indicate that subject to UDHC and the Government undertaking the specified actions to mitigate possible risks, UDHC should be able to generate sufficient revenues each year to meet its financial obligations to cover its (a) cash operating expenses, (b) debt service, and (c) agreed contributions to debt service, and to meet the financial performance indicators discussed below.

50

Annex 7, Attachment 1: UDHC - Projected Key Financial Indicators

Unit 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Retail heat sales area served - residential million m2 9.7 13.3 17.7 22.1 24.3 25.6 25.6 25.6 25.6 25.6 25.6 25.6 - non-residential million m2 4.3 6.0 8.6 10.9 12.0 12.7 12.7 12.7 12.7 12.7 12.7 12.7 Retail heat sales MWh 2763772 3215497 4217813 5378246 6307354 6150549 6851618 6851618 6851618 6851618 6851618 6851618 volume Bulk heat sales MWh 70966 512687 1722068 2874705 3373360 3373360 3373360 3373360 3373360 3373360 3373360 3373360 volume Residential heat sales price (including VAT RMB/m2 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 of 13%) Non-residential heat sales price (including RMB/m2 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 VAT of 13%) Bulk heat sales price (including VAT of RMB/MWh 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 22.0 13%) Total heat purchases MWh 2318566 2988876 5419934 7778015 9132235 9485051 9684223 9684223 9684223 9684223 9684223 9684223 Average heat RMB/MWh 53.3 41.4 41.4 41.4 41.4 41.5 41.5 41.5 41.5 41.5 41.5 41.5 purchase price

Invoiced sales RMB 000 301739 446607 680409 905772 1014836 1057504 1057504 1057504 1057504 1057504 1057504 1057504 revenues Collected revenues RMB 000 271565 401947 612368 824253 923501 972904 972904 983479 983479 994054 994054 1004629 Cash operating RMB 000 201892 213926 360051 492045 557487 576205 584627 584627 584627 584627 584627 584627 expenses Total operating RMB 000 272546 327520 545318 730025 822572 840964 851238 841192 841192 831145 831145 821099 expenses Net income after tax RMB 000 10605 58211 34822 51703 66060 91393 104550 106182 116336 134575 143197 159821 Debt service RMB 000 16716 50604 149291 192834 216866 211338 251955 302816 304134 271390 239912 230402

Annual working ratio (cash opex/collected % 100% 81% 89% 89% 89% 86% 87% 86% 86% 84% 84% 82% revenues)

51

Operating ratio (operating % 90% 73% 80% 81% 81% 80% 80% 80% 80% 79% 79% 78% expenses/billed revenues) Collection ratio (collected % 90% 90% 90% 91% 91% 92% 92% 93% 93% 94% 94% 95% revenues/billed revenues) Current ratio (current assets/current ratio 1.8 1.4 1.3 1.3 1.5 1.7 1.8 1.9 2.3 2.7 3.1 3.6 liabilities) Debt service coverage (net income after tax + interest + ratio 4.1 3.6 1.7 1.7 1.7 1.8 1.6 1.3 1.3 1.4 1.6 1.7 depreciation/interest + principal repayment) Note: Figures without adjustment for annual inflation in prices.

52

19. Key financial performance indicators. The three key indicators that will be closely monitored during project implementation are: (a) the working ratio (cash operating expenses/collected revenues) which measures the combined effect of efficiencies in controlling cash operating expenses and in collection performance; and (b) the current ratio (current assets/current liabilities) that indicates the overall liquidity situation, including the ability to meet short-term obligations. 20. Financial covenants. The main covenants proposed are the following: (a) The Government to ensure that adequate funds are available to enable UDHC to meet its financial obligations under the project, including enabling timely and adequate (i) tariff increases and (ii) funds required to cover any shortfalls that may affect project implementation. (b) Starting with the year ending December 31, 2011, UDHC to (i) maintain a working ratio of not more than 90%; and (ii) maintain a current ratio (current assets/current liabilities) of not less than 1.3. (c) Each year, UDHC to prepare and discuss with the Bank its financial performance for the current year and forecasts for the next year, and take steps as necessary to meet the agreed financial ratios. 21. Assessment of the Project’s Financial Viability. The project‟s financial viability has been assessed based on a comparison of the financial rate of return (FRR) with the weighted average cost of capital (WACC). Comparisons have been made separately for each of the two components (SHN and UHN) and for the project as a whole. The results show that the FRR is above the WACC for each component and for the project as a whole (summary in table below and details in Attachment 2 to the Annex). The project FRR also meets the Government‟s feasibility study guidelines on required rates of return for similar public infrastructure projects. The FRR is sufficient to enable UDHC to maintain selected key financial indicators (working ratio and debt service coverage) at acceptable levels (indicated in Attachment 1 to this Annex).

Project Financial Rates of Return Component FRR WACC SHN (Shayibake) 10 4.07 UHN (Urumqi 6 4.01 Weidian III) Total Project 8 4.03

22. Sensitivity Analysis. Key variables that could impact on the FRR are: (a) heat sales tariffs; (b) heat demand; (c) collection performance; and (d) heat purchase price. Table below indicates the switching levels (increases/decreases over the base value) of these variables at which the FRR would fall below the WACC for each of the components.

53

Switching Values for Key Variables

SHN UHN Total Variable Component Component Project Heat sales tariff -15% -5% -10% Heat sales demand -15% -5% -10% Collection performance -14% -5% -10% Heat purchase price 40% 15% 25%

54

Annex 7, Attachment 2: UDHC - Project Financial Rate of Return Analysis for SHN & UHN Components (Million RMB)

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029

SHN COMPONENT Annual capital expenditure -392 -326 -233 Incremental cash operating expenses -22 -68 -114 -133 -133 -133 -133 -133 -133 -133 -133 -133 -133 -133 -133 -133 -133 -133 -133 -133 Incremental revenues 59 137 219 242 242 242 242 242 242 242 242 242 242 242 242 242 242 242 242 242 Net incremental benefits -355 -257 -129 109 109 109 109 109 109 109 109 109 109 109 109 109 109 109 109 109 FRR = 10%

UHN COMPONENT Annual capital expenditure -300 -619 -244 -97 -32 Incremental cash operating expenses -13 -58 -117 -139 -144 -147 -147 -147 -147 -147 -147 -147 -147 -147 -147 -147 -147 -147 -147 -147 Incremental revenues 26 129 215 248 259 259 259 259 259 259 259 259 259 259 259 259 259 259 259 259 Net incremental benefits -287 -547 -146 12 83 113 113 113 113 113 113 113 113 113 113 113 113 113 113 113 FRR = 6%

55

BOTH SHN & UHN TOGETHER Annual capital expenditure -693 -945 -478 -97 -32 Incremental cash operating expenses -35 -126 -230 -272 -278 -280 -280 -280 -280 -280 -280 -280 -280 -280 -280 -280 -280 -280 -280 -280 Incremental revenues 85 266 433 490 501 501 501 501 501 501 501 501 501 501 501 501 501 501 501 501 Net incremental benefits -642 -805 -275 121 192 221 221 221 221 221 221 221 221 221 221 221 221 221 221 221 FRR = 8%

56

Annex 8: Map CHINA: Urumqi District Heating Project

57

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, or any endorsement or acceptance of such boundaries. ALTAYALTAY PREFECTUREPREFECTURE

MIDONGMIDONG DISTRICTDISTRICT 0 20

KILOMETERS

WUJIAQUWUJIAQU SUB-PREFECTURE-SUB-PREFECTURE- CHANGJICHANGJI HHUIUI -LEVEL-LEVEL CCITYITY AUTONOMOUSAUTONOMOUS PPREFECTUREREFECTURE CHANGJICHANGJI HHUIUI AUTONOMOUSAUTONOMOUS PPREFECTUREREFECTURE

To Shihezi

HutubiHutubi WujiaquWujiaqu FukangFukang

ÜRÜMQIÜRÜMQI MIDONGMIDONG COUNTYCOUNTY DISTRICTDISTRICT ChangjiChangji To Kumul TOUTUNHETOUTUNHE MidongMidong DISTRICTDISTRICT XINSHIXINSHI DISTRICTDISTRICT SHUIMOGOUSHUIMOGOU ÜRÜMQIÜRÜMQI DISTRICTDISTRICT SHAYIBAKESHAYIBAKE TIANSHANTIANSHAN DISTRICTDISTRICT DISTRICTDISTRICT

DABANCHENGD A B A N C H E N G DISTRICTD I S T R I C T

ÜRÜMQIÜ R Ü M Q I CCOUNTYO U N T Y

DabanchengDabancheng

To Turpan

To Toksun DABANCHENGDABANCHENG DISTRICTDISTRICT To Bayingolin TURPANTURPAN PREFECTUREPREFECTURE

BAYINGOLINBAYINGOLIN MMONGOLONGOL AUTONOMOUSAUTONOMOUS PPREFECTUREREFECTURE

RUSSIAN FEDERATION KAZAKHSTAN HEILONGJIANG CHINA URUMQI DISTRICT HEATING AND ENERGY JILIN MONGOLIA Sea of Ürümqi EFFICIENCY PROJECT KYRGYZ REP. Area of Map LIAONING D.P.R. OF Japan L GO BEIJING KOREA XINJIANG UYGUR AUTONOMOUS REGION MON XINJIANG UYGUR NEI BEIJING AUTONOMOUS REGION TIANJIN HEBEI REP. OF

SHANXI SHANDONG Yellow KOREA JAPAN Sea PROJECT DISTRICTS

QINGHAI NINGXIA JIANGSU GANSU MAIN TOWNS OR CITIES SHAANXI HENAN

ANHUI SHANGHAI PREFECTURE CAPITALS XIZANG HUBEI East SICHUAN NG ZHEJIANG NEPAL China PROVINCE CAPITAL

CHONGQI Sea HUNAN JIANGXI EXPRESSWAYS FUJIAN National Capital GUIZHOU RAILROADS TAIWAN YUNNAN GUANGDONG Province Capital GUANGXI Philippine DISTRICT/COUNTY BOUNDARIES MARCH 2011 IBRD 38490 HONG KONG Sea Province Boundaries MACAU PREFECTURE BOUNDARIES VIETNAM

InternationalBay Boundaries of MYANMAR LAO P.D.R. HAINAN Bengal THAI- PHILIPPINES LAND