Document of The World Bank Public Disclosure Authorized

Report No: 35842-CHA

IMPLEMENTATION COMPLETION REPORT (SCL-42370 TF-29395)

ON A Public Disclosure Authorized LOAN

IN THE AMOUNT OF US$95 MILLION

TO THE

PEOPLE'S REPUBLIC OF CHINA

FOR THE

SHANDONG ENVIRONMENT PROJECT Public Disclosure Authorized

June 29, 2006

Urban Development Sector Unit East Asia and Pacific Region Public Disclosure Authorized CURRENCY EQUIVALENTS (Exchange Rate Effective December, 2005) Currency Unit = Renminbi (RMB) or Yuan (Y) Y1.00 = US$ 0.12 US$ 1.00 = Y8.00

FISCAL YEAR January 1 December 31

ABBREVIATIONS AND ACRONYMS

CAS Country Assistance Strategy CHP Combined Heat and Power EA Environmental Assessment EPB Environmental Protection Bureau ICB International Competitive Bidding JMDC Jinan Municipal Drainage Company JMG Jinan Municipal Government JWSC Jinan water Supply Company LIBOR London Interbank Borrowing Rate Mpa Mega Pascals (pressure) MW Megawatt NCB National Competitive Bidding NDRC National Development Reform Commission NO2 Nitrous Oxide PHRD Population and Human Resources Development (Japanese Grant) QCBS Quality and Cost Based Selection RAP Resettlement Action Plan SEPA State Environmental Protection Agency SEPB Shandong Environmental Protection Bureau SMO Sub-loan Management Office SO2 Sulphur Dioxide SP Shandong Province SFB Shandong Finance Bureau SPG Shandong Provincial Government SPPMO Shandong Provincial Project Management Office STW Sewage Treatment Works TSP Total Suspended Particulates UNEP United Nations Environment Program WBHPC Weihai Botong Heat and Power Company Ltd. WWTP Wastewater Treatment Plant XR(B) Xiaoqing River (Basin) XRBSL Xiaoqing River Basin Sub Loans YHSC Yantai Heat Supply Company Ltd.

Vice President: Mr. Jeffrey Gutman, Acting EAPVP Country Director: Mr. David Dollar, EACCF Sector Director: Mr. Keshav Varma, EASUR Task Team Leader: Ms. Shenhua Wang, EASUR

CHINA SHANDONG ENVIRONMENT PROJECT

CONTENTS

Page No. 1. Project Data 1 2. Principal Performance Ratings 1 3. Assessment of Development Objective and Design, and of Quality at Entry 2 4. Achievement of Objective and Outputs 5 5. Major Factors Affecting Implementation and Outcome 11 6. Sustainability 12 7. Bank and Borrower Performance 13 8. Lessons Learned 15 9. Partner Comments 16 10. Additional Information 16 Annex 1. Key Performance Indicators/Log Frame Matrix 17 Annex 2. Project Costs and Financing 31 Annex 3. Economic Costs and Benefits 34 Annex 4. Bank Inputs 36 Annex 5. Ratings for Achievement of Objectives/Outputs of Components 38 Annex 6. Ratings of Bank and Borrower Performance 39 Annex 7. List of Supporting Documents 40 Annex 8. Land Acquisition and Resettlement 41 Annex 9. Borrower’s Implementation Completion Report 42 Map: IBRD 28428

Project ID: P040185 Project Name: SHANDONG ENVIRONMENT PROJECT Team Leader: Shenhua Wang TL Unit: EASUR ICR Type: Core ICR Report Date: June 29, 2006

1. Project Data Name: SHANDONG ENVIRONMENT PROJECT L/C/TF Number: SCL-42370; TF-29395 Country/Department: CHINA Region: East Asia and Pacific Region Sector/subsector: District heating and energy efficiency services (43%); Water supply (30%); General water, sanitation and flood protection sector (18%); General industry and trade sector (5%); Sub-national government administration (4%) Theme: Municipal governance and institution building (P); Pollution management and environmental health (P); Water resource management (P); Environmental policies and institutions (P)

KEY DATES Original Revised/Actual PCD: 04/19/1996 Effective: 07/30/1998 Appraisal: 01/18/1997 MTR: 04/17/2002 Approval: 10/28/1997 Closing: 12/31/2003 12/31/2005

Borrower/Implementing Agency: PEOPLE'S REPUBLIC OF CHINA/SHANDONG URB. & RURAL CONST. COM/ENV. PROT. BUREAU-SURC/SEPB Other Partners:

STAFF Current At Appraisal Vice President: Jeffrey S. Gutman Jean-Michel Severino Country Director: David Dollar Yukon Huang Sector Manager: Keshav Varma Richard G. Scurfield Team Leader at ICR: Shenhua Wang Geoffrey Read ICR Primary Author: Chandra Godavitarne

2. Principal Performance Ratings

(HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible) Outcome: S Sustainability: L Institutional Development Impact: M Bank Performance: S Borrower Performance: S

QAG (if available) ICR Quality at Entry: S Project at Risk at Any Time: Yes QAG did not review the project for quality at entry. 3. Assessment of Development Objective and Design, and of Quality at Entry 3.1 Original Objective:

Background. Rapid growth in the industrial and service sectors in Shandong Province (SP) over the past two decades resulted in serious environmental degradation in urban areas, particularly in the capital city of Jinan, in the coastal cities of Qingdao, Weihai and Yantai, and in Zibo in the Xiaoqing River Basin (XRB). With Shandong's vast coal deposits, thermal power generation, industrial process heating and residential heating, all use coal as their primary energy source. This level of coal use resulted in Shandong having the largest mass emissions of SO2 among China’s provinces. Pollution in the Xiaoqing River (XR), posed serious threats to human health, and to economic development. By the mid-90s, Shandong Province (SP) had invested heavily in industrial pollution control, principally in wastewater treatment and air pollution control. At the same time, concerns were growing over the reliability of Jinan’s water supply due to over-abstraction of groundwater and its deteriorating water quality. Groundwater was supplemented with supplies from impounding reservoirs and direct abstractions from the Yellow River. The long-term water resources management strategy of the Province was to construct reliable surface water sources, conserve groundwater, and adopt water reuse in industry. Against this background, SP requested Bank assistance for the Shandong Environment Project.

The project had the following objectives: (a) strengthen policies, regulations and institutional arrangements for municipal water, wastewater, and district heating, and environmental pollution prevention and control; (b) expand surface water supply to Jinan to prevent further depletion of groundwater aquifers; (c) facilitate sustainable management of investments in pollution control and municipally-provided urban environmental services; and (d) arrange for updating the information data base with respect to water quality and management of the XRB.

Assessment of Objectives. The project's objectives were in line with the Bank’s Country Assistance Strategy (CAS) which was discussed by the Board in June 1995, and which highlighted environmental protection and reducing infrastructure bottlenecks as two of the five areas of strategic focus. The objectives were consistent with China’s Environmental Action Plan (EAP), which provided the basis for joint Government-Bank programs in the environmental sector, and the provincial government’s strategy to address serious pollution issues associated with its rapid industrial growth.

Specifically, the project objectives were fully consistent with the Provincial Government's XRB Environmental Action Plan (EAP), which addressed the serious pollution issues of the Basin and in the Xiaoqing River, which flows to the environmentally sensitive Bohai Sea. Objectives also focused on the looming water scarcity, development of a reliable surface water source for Jinan to arrest the depletion of groundwater resources, and serious air pollution in two key coastal cities. Lastly, the project focused on policy, regulatory and institutional reforms in the implementing utility companies.

Project objectives correctly focused on SP’s priority environmental problems and were clear and realistic. The objectives reflect recognition of the priority need for regulatory and institutional reform, relieving Jinan’s water scarcity, and preventing, reducing and controlling of air and wastewater pollution. At the same time, the project was challenging due to its spatial distribution, the fact that it covered three sectors in three cities, and it also dealt with reforms in district heating, an area where China had limited experience.

3.2 Revised Objective: n.a.

3.3 Original Components:

- 2 - The project had five components, for a total project cost of US$202 million.

(a) Jinan Water Supply Management ($62.6 million). Development of a reliable new surface water source, adequate for about 20 years, from the Yellow River for Jinan, to supply raw water to a newly constructed water treatment plant of 400,000 m3/day capacity, including pumping stations, water transmission and distribution pipelines, and associated engineering works.

(b) Jinan Wastewater Management ($36.5 million). Construction of a wastewater collection network comprising about 18 km of trunk sewers, about 17 km of secondary and link sewers, a pumping station, and property connections, to convey wastewater to a newly constructed wastewater treatment plant of 220,000 m3/day capacity.

(c) Weihai Municipal District Heating ($42.9 million). Construction of a combined heat and power generation plant of about 24 MWe electricity and 120 MWt heat capacity, 13.7 km heat and 14.2 km hot water distribution networks and facilities, and heat exchange stations, to reduce inefficiencies in coal-fired small boilers and stoves.

(d) Yantai Municipal District Heating ($46.1 million). Construction of a heat exchange plant, about 30 km of distribution networks and heat exchange stations for about 500 MWt heating capacity and a peak boiler of about 112 MWt capacity, to reduce inefficiencies in coal-fired small boilers and stoves.

(e) Environmental Pollution Prevention and Control ($10.0 million). Creation of a revolving sub-loan facility for environmental improvements in small- and medium-size enterprises located in the XRB, to assist them to comply with environmental regulations of the Basin.

(f) Institutional Strengthening and Training ($3.9 million). Technical assistance to support and strengthen provincial, municipal, project and financial management; construction supervision; training in sector and utility operations; and updating of the XRB water quality and management database.

Assessment of Project Design. Project design is assessed as satisfactory, as it was closely linked to project objectives, and was highly appropriate to the pressing environmental problems of the Province at the time. It incorporated lessons learned from past urban environmental projects in China and relevant sectors. Lessons included: strong ownership by the Borrower; the use of a river basin approach to environmental management; support for institutional reforms; and the application of cost recovery and demand management through pricing.

Project design correctly recognized the need to strengthen the trunk network to distribute the additional water produced under the new scheme, to fully utilize the capacity of the existing wastewater treatment plant, and to minimize the adverse economic and environmental impacts from the continued use of inefficient small boilers and stoves for district heating.

Even though SP had participated in 27 Bank-financed investment operations with a good track record, the design recognized the need for institutional strengthening, project management inputs and training for the four sector agencies, three of which were new companies, with no prior experience in implementing Bank-financed projects.

3.4 Revised Components: The Loan Agreement was amended on December 16, 2004 to add the following investments to the water supply and district heating components, to utilize Loan savings of about $17 million:

- 3 - (a) Jinan Water Supply. About 25 km of new trunk water distribution network to extend services to the eastern part of Jinan;

(b) Weihai Municipal District Heating. A 130 t/h steam boiler to increase heat/steam production capacity, and a 25 MWe turbine and generator for the project power plant to increase its electricity production capacity to 49 MWe; and

(c) Yantai Municipal District Heating. About 20 km of heat supply pipeline in the southern part of the city to increase the consumer connection load to about 680MWt.

Assessment of Design. The additional components were consistent with project objectives, represented least-cost solutions, and enhanced the benefits of the three components.

3.5 Quality at Entry: The project’s quality at entry was not reviewed by the Bank's Quality Assurance Group.

Quality at entry is rated as satisfactory based on the following: (a) component designs addressed SP's most serious environmental issues, and were high priority for SP; (b) consistency with country, Province and Bank strategies; (c) adoption of a river basin approach to environmental management; (d) incorporation of institutional reforms to strengthen policies/regulations, and support for institutional development and corporate financial management; (e) attention given during project preparation to the results of sector studies, lessons learned and the performance of implementing agencies in other projects; (f) implementation of Government and Bank policies on environment and resettlement; and (g) preparation of feasibility studies and related documents to a satisfactory standard.

The Xiaoqing River Basin Sub-Loan Facility (XRBSL) was well designed with clear loan criteria and procedures for appraisal, disbursements and cost recovery, including a procedure to certify completion of investments. However, the component did not require SPG to replenish the funds to assure its continuation.

The assumptions about demand for project outputs were largely reasonable even though it was possible to sell only about half of all available water due to continued use of groundwater by some industries in the eastern areas of Jinan.

Following assurances given at negotiations, expansion of the Jinan water distribution network was to be completed by JWSC by December 2000. However these works were not executed due to scarcity of funds. In hindsight, it could be concluded that this important distribution network should have been included in the project at least as reserve procurement, rather than relying on a dated covenant.

The quality of feasibility studies and preliminary designs, prepared by domestic design institutes, was enhanced by the design review advisory services provided by international consultants. By negotiations, detailed designs and draft bidding documents were prepared for about 20% of the total project works.

The project triggered the Bank’s safeguard policies on environmental assessment and involuntary resettlement, and the project was classified as Category "A". Component-specific EAs and a comprehensive project-wide EA were prepared, including mitigation measures to address negative impacts, and an implementation plan to ensure satisfactory implementation. RAPs were prepared for each component in accordance with Bank requirements. The RAPs included a framework for land acquisition

- 4 - and resettlement, compensation schemes, preferential policies to reduce taxes and levies for the project affected people, and implementation and monitoring arrangements. During negotiations, assurances were obtained from SPG and local municipal governments that the resettlement and rehabilitation of affected persons would be conducted according to Bank guidelines (see 4.1 below).

Key performance indicators to monitor achievement of the project's objectives were developed along with baseline conditions, and were available at start-up. The indicators were comprehensive and comprised useful baseline environmental conditions (details in Annexes 1, 1A, 1B, 1C and 1D). The data was regularly updated by the Shandong Environmental Protection Bureau (EPB), as part of the XRB water quality and management database.

Risk Assessment

Risks identified at appraisal were: wastewater treatment not achieving targets, water supply not reaching targets; quality of implementation inadequate; inefficient cost recovery over project period; counterpart funding insufficient or late; environmental pollution control measures not effectively enforced; and lack of enforcement and development control. Long-term strategic risks identified included: continued decline in water quality of XRB and groundwater quantity and quality; deterioration in the ambient air quality in urban areas, limited capacity of utility companies to expand environmental services because they are not financially viable.

The assumptions made in the SAR were reasonable and the risk assessment was largely accurate. Mitigation measures included in the project were: technical assistance and training to strengthen capacity of authorities and utility operators; commitment to water supply network expansion; provision of competent local and international supervision consultants during construction; commitment to tariff increases and financial planning; integration of monitoring and pollution control functions by EPB, etc. These measures proved adequate.

One risk that was not anticipated was industry's continued use of self-supply groundwater due to the inability of the provincial and Jinan Municipal Governments to enforce regulations banning self-supply when a piped supply was available. This affected JWSC's finances and its ability to recover costs for the new water supply during the initial years of operation.

4. Achievement of Objective and Outputs 4.1 Outcome/achievement of objective: Achievement of objectives is rated satisfactory as shown in Table 4.1.

Table 4.1: Outcome/Achievement of Objective Project Objective Rating (a) Strengthen policies, regulations and institutional arrangements for municipal water, Moderately wastewater, and district heating, and environmental pollution prevention and control satisfactory (b) Expand surface water supply to Jinan to prevent further depletion of groundwater Satisfactory aquifers (c) Facilitate sustainable management of investments in pollution control and Satisfactory municipally-provided urban environmental services (d) Arrange for updating the information database with respect to water quality and Satisfactory management of XRB.

- 5 - Objective (a) Achievement of this objective is rated as moderately satisfactory, for the reasons described below.

(a) The Jinan Water Supply Company (JWSC). JWSC has operated in accordance with the provisions of its charter as an autonomous utility company, including retaining its tariff revenue to manage its operations and maintenance and debt servicing. In November 2002, JWSC entered into a public private partnership with a private operator, for operation of its Yellow River Water Treatment Plant under a ‘transfer-operate-transfer’ contract. Lack of enforcement by SPG and the Municipality of existing municipal regulations and State Council directives of 2000 and 2004, which ban self supply where a service is available, has encouraged some industries to continue the use of self-supply groundwater. The water resource fee levied by the Water Resources Bureau is marginally lower than JWSC’s industrial tariff, so industries do not have an incentive to switch to piped supply. The objective of arresting the depletion of the groundwater aquifer has thus been only partially achieved.

(b) The Jinan Municipal Drainage Company (JMDC). Regulations of the newly formed JMDC require all buildings in its service area to connect to the sewer system, and industry to treat its wastewater to specified standards before discharge to the sewer system. SPG has adopted the policy to increase cost recovery in the wastewater sector.

The newly formed JMDC owns and operates the wastewater treatment plant (WWTP) in Jinan and the project-financed collection networks; the secondary and tertiary network continue to be owned and maintained by the district sanitation units, with an annual budget from JFB – a practice common in Chinese cities.

The component contributed to reduce wastewater pollution entering the XR: (i) pollution contribution to the Daming Lake (and the XR) from current wastewater generated in Jinan (370,000 m3/day) has been halved, utilizing the full capacity of the existing treatment plant of 220,000 m3/day; (ii) water quality in the Daming Lake has improved, and the BOD and COD levels in the Lake have declined by about 30 percent and 50 percent respectively (see Annex 1B: Table 1 and Chart); (iii) the COD and BOD loads in the influent wastewater have declined (see Table and Chart in Annex 1B); and (iv) environmental conditions have improved in the serviced areas, as most of the wastewater generated is now conveyed to the treatment plant. However, about 150,000 m3/day of wastewater is still being discharged untreated to XR, due to treatment capacity limitations. JMDC plans to increase wastewater treatment capacity by 550,000 m3/day by 2008, but a firm implementation plan is not yet in place (see Table 3 Annex 1B).

(c) The Weihai Botong Heat and Power Company (WBHPC) and the Yantai Heat Supply Company (YHSC). Both Weihai and Yantai established regulations that require discontinuance of stoves and boilers up to 10 ton/hour capacity, where heating networks are available. No individual heating facilities are permitted in newly constructed buildings within the companies' service areas. All buildings in the serviced areas are required to connect to the heating networks.

Early in implementation, the existing municipal district heating departments were converted to state-owned companies with a business license; both companies operate in accordance with the provisions of their charters as autonomous enterprises. With the project's technical assistance, both companies improved their financial management and can now provide an up-to-date picture of their finances. In 2001, WBHPC was converted from a 100% state-owned company to a joint-stock company with 52% owned by the municipality, and the balance by private investors and employees.

According to Shandong Environmental Protection Bureau monitoring data (a) air quality improved in both

- 6 - cities through significant reductions in SO2, NO2 and TSP levels (see Tables 2 and 3 and Chart in Annex 1C); (b) in Weihai, about 100 industrial boilers and about 18,000 household stoves have been demolished or discontinued; (c) in Yantai, about 247 industrial boilers and about 64,000 household stoves have been demolished or discontinued in the downtown area; (d) visibility has improved significantly in the heating season (see Table and Chart in Annex 1C); and (e) Yantai officials attribute the return of the seagull population to the improved air quality.

(d) Environmental Pollution Prevention and Control. SPG has a comprehensive policy for pollution prevention and control in the XRB. Regulations promulgated by the Xiaoqing River Basin Commission require: phased closure of paper mills of capacities up to 20,000 tons/year; bans on the use of certain raw materials for paper-making; reduction of direct discharge to XR by paper mills; relocation of specified polluting industries; and adoption of wastewater recycling by all enterprises to specified targets. (Details are provided in Annex 1D). SP has increased municipal wastewater treatment and introduced measures for pollution load reduction from the worst polluting industries, and mass-based pollution load targets for the Xiaoqing River are to be achieved in 2005 and 2010. Under the project, SPG assisted small and medium industries to comply with the environmental regulations of the XRB. Untreated municipal wastewater discharged to the Xiaoqing River from all five municipalities in the Basin has declined by about 910,000 m3/day following commissioning of new municipal wastewater treatment plants in the towns of Jinan, Zibo, Dongying, Weifang and Bingzhou. Water quality data for the Daming Lake and the Xiaoqing River illustrating the reduction in BOD, COD and SS following the operation of the Jinan wastewater treatment plant and other activities in the XRB, are provided in Annex 1D.

Objective (b) Achievement of this objective is rated satisfactory. A reliable and secure surface water source for Jinan, adequate to meet demand through at least 2020, is now available. The current supply is able to provide raw water to operate the 400,000 m3/day treatment plant. The supply has been expanded to eastern areas of the city. The static level of groundwater has risen about 2.5 meters since 1997; conditions are likely to improve further when use of self-supply water by industries is stopped. Natural springs, a tourist attraction of Jinan, have reappeared. The table and chart in Annex 1A illustrate the recovery of groundwater levels since 1997.

Objective (c) Substantial progress has been made in water supply, wastewater and district heating utilities towards achieving this objective. Sustainable management of investments in the sectors is assessed as likely. Supported by SPG, municipalities have plans and policies in place for all utilities to recover costs through regular tariff revisions; these plans have been implemented towards achieving this goal. Overall, progress made is considered satisfactory. JWSC was profitable for many years prior to the completion of the new water supply scheme, and continued to meet financial covenants in 2004 and 2005, although it did require municipal subsidies. These subsidies were required as SP and JMC did not enforce regulations to stop self-supply once the JWSC supply became available. SPG has taken action to assure sustainable wastewater management in all municipal cities. A Government directive requires all cities in Shandong to implement a specified minimum tariff starting January 1, 2005. JMDC has adopted the following tariffs: Y0.70/ m3 for domestic, Y0.80/ m3 for industry and Y0.90 /m3, representing an average increase of about 100 percent. This increase was adequate to meet about 86 percent of total revenue requirements prior to full operation of the treatment plant. Further tariff increases are necessary to meet the objective; Shandong Province is committed to implementing the tariff increases in the near term.

Finances of the district heating companies in Weihai and Yantai have been generally satisfactory since their formation in 1996. Periodic tariff increases have assured their sustainability; thus sustainability of the district heating operations in both cities is likely. Prospects for Weihai are even brighter, since about 40 percent of revenue is derived from the sale of excess power generated by the power plant financed under the

- 7 - project.

Objective (d) The Provincial Environmental Protection Bureau has continued to update the information database on water quality and management of the XRB. This information has been used to monitor the implementation progress of the XRB EAP, and to make necessary modifications. Achievement of this objective is rated satisfactory. Most of the data in Annex 1 is derived from this database.

Environmental and Social Objectives (Safeguards).

Overall, the project met its safeguard objectives satisfactorily. The EMP was fully implemented during the project period. Land acquisition and resettlement were implemented in accordance with the resettlement action plans (RAP) except in one instance, where the JMG departed from the agreed RAP in the wastewater component. Resolution of this matter took over two years, during which period the project was rated ‘unsatisfactory’. Annex 8: Experiences in Land Acquisition and Resettlement provides more details of the non-compliance. EAs and RAPs meeting Bank requirements were prepared for the additional components included in the project, and were implemented satisfactorily.

4.2 Outputs by components: Overall, achievement of project outputs is rated satisfactory. Construction supervision and quality control for the physical investments were carried out by supervision companies and the Government’s Quality Control Office respectively. Assistance was also provided by international consultants. Construction quality was satisfactory. Output ratings are provided in Table 4.2 below.

Table 4.2: Output Ratings

Component Rating (a) Jinan Water Supply Satisfactory (b) Jinan Wastewater Satisfactory (c) Weihai District Heating Satisfactory (d) Yantai District Heating Highly satisfactory (e) Xiaoqing River Basin Environmental Pollution Control Satisfactory (f) Institutional Strengthening and Training, including Updating the Satisfactory Environmental Database

(a) Jinan Water Supply. The appraisal target was to provide a continuous supply of 440,000 m3/day of desilted raw water to fully utilize the existing capacity at the Huanghe No. 2 WTP to enable supply of 400,000 m3/day of treated water to existing and new development areas of the city. The component outputs exceeded targets set at appraisal, as the project also financed 25 km distribution network, through the use loan savings. An estimated 300,000 people benefited from the new water supply. In addition, there were general service improvements to about 2 million people in JWSC's service area.

(b) Jinan Wastewater. Facilities constructed under the project include trunk sewers, force mains, secondary sewers, missing links, connections, and associated pumping stations, with capacity to collect and convey about 580,000 m3/day of wastewater generated in all six drainage catchments through 2020. About 370,000 m3/day of wastewater flows to the treatment plant. A total of 1.05 million people benefited from the improved wastewater collection.

(c) Weihai District Heating. The system now comprises a combined heat and power plant of 49 MWe electric and 180 MWt heat capacity (from the original 120 MWt capacity); 13.7 km of steam network of

- 8 - about 75 tons/hour, about 14.2 km of hot water network of about 68 MWt capacity, and 10 heat exchanger stations of varying capacities averaging about 6 MWt. The pre-project capacity of the two thermal power plants in Weihai was inadequate to meet the heat and electricity demand in the south of the city center in a developing industrial zone. As a result of the project, the demand for heat and steam has been met. WBHPC derives additional revenue from the sale of excess power.

The combined heat and power plant (CHP plant) was originally planned for an electric power production capacity of 24 MWe. With loan savings, the total electric power production capacity was increased to 49 MWe. All the originally planned 243 substations and 30 new additional substations have been added to the network for the expanded heating area. Services were improved to the 108,000 people in WBHPC's service area, and an additional 30,000 people benefited from improved heating services.

(d) Yantai District Heating. All elements of the component were installed as planned within the project time schedule and budget. The number of installed heating substations has reached the planned 87, enabling expansion of coverage of the heated area to the planned 8 million m2. About 450,000 people in YHPC's service area benefited from improved heating services. Since Yantai’s bulk heat suppliers have increased their production capacities, it enabled YHSC to expand its original heat supply capacity and eliminated the need for the planned peak boiler plant. This saving enabled the financing of the extended heating pipelines to the southern parts of the city, thus increasing benefits within the original project cost. YHSC now has almost 600 MWt heat production capacity against the current heat demand of 500 MWt. In addition to the increased heat production capacity, overall efficiency of the whole system has improved with reduced emissions and increased coverage.

(e) Xiaoqing River Basin Environmental Pollution Control. The revolving sub-loan facility was a pilot initiative, managed by the Shandong EPB, to support small and medium-size industries to meet environmental regulations in the Xiaoqing River Basin. The component supported environmental improvements, primarily in wastewater treatment and process modifications. The sub-loan facility has been fully disbursed to 32 industries. All industries participating in the sub-loan facility were required to carry out clean production audits. According to SEP, this pilot initiative has helped to promote the Province’s clean production program. Loan repayments have averaged about 50 percent; in the remaining cases, SFB recovered the funds from local governments through adjustments to annual budget transfers. The sub-loan facility continues to operate as a revolving fund facility. The overall impact of the sub-loans on reducing pollution was positive.

(f) Institutional Strengthening and Training. Technical assistance and training were imparted to the four agencies (JWSC, JMDC, WBHPC and YHSC) under the institutional strengthening technical assistance consultancy. The consultants developed job descriptions, definition of responsibilities, enterprise accounting, financial projections, tariff recommendations, reporting systems, hands-on training and study tours. The utility companies indicated that the support was useful and welcome, and that the recommendations were generally embraced and implemented. Training is summarized below.

Type JWSC JMDC YHPC WBHPC Overseas Training 14 16 7 16 Local Training 220 120 347 256 Total 234 136 354 272

Project technical assistance also included construction supervision support to SPPMO and implementing agencies, which employ domestic supervision companies for these services. There have been no concerns

- 9 - about construction quality. However, there have been issues with contract administration, especially with regard to contract variations. During the first two years of implementation, contract variations were either not well prepared, or were submitted for late Bank approval. International expertise could have been better focused to improve contract management and construction supervision through closer integration with the implementing agencies and supervision companies.

In principle, the initiatives taken by JWSC and WBHPC in public-private participation are positive and are consistent with Bank policies.

The information database on water quality and environmental management of the XRB has been regularly updated by SP EPB and the information has been used by government for monitoring the environment.

4.3 Net Present Value/Economic rate of return: An overall economic rate of return of the entire project was not calculated at appraisal. ERRs were calculated using least-cost analysis only for those components for which appropriate data was available to monetize and quantify economic benefit streams. For the wastewater component, which included only networks, data was not readily available and economic benefits were not quantified. At project completion, using the same method, the immediate net benefit to the serviced population was recalculated, and is summarized in Table 4.3; see Annex 3 for details.

Table 4.3. Costs and Benefit at Appraisal and Completion ERR (%) and NPV (@12%, Y Million)

Appraisal ICR Components Method Options NPV ERR NPV ERR Jinan Water Supply Least-Costs 146.80 18% 57.76 14%

Jinan Wastewater Cost Effective na na na na Excluding envir benefits 415.27 31% 425.42 31% Weihai District Heating Least-Costs Full costs analysis 548.97 37% 566.40 37% Excluding envir benefits 535.35 66% 559.08 65% Yantai District Heating Least-Costs Full costs analysis 657.26 71% 685.01 70%

4.4 Financial rate of return: Financial rates of return were not estimated at appraisal.

4.5 Institutional development impact: Overall, the project's institutional development impact is rated modest. Good use was made of the training offered by the project and key staff involved in implementation has been retained. Improved financial procedures and management systems were introduced in all four companies through the project technical assistance, which were well received and internalized. The financial projections helped the companies to formulate recommendations for necessary annual tariff revisions. Procurement, using World Bank procedures, was carried out satisfactorily by all implementing agencies, except for one case of mis-procurement in Yantai. In line with current trends in China, two companies (JWSC and WBHPC) undertook PPP initiatives. While the developments thus far have been satisfactory, the utility companies should continue progress towards greater autonomy in financial and operational management.

- 10 - 5. Major Factors Affecting Implementation and Outcome 5.1 Factors outside the control of government or implementing agency: Due to a slowdown in the development of the urban areas of Weihai during 1999-2002, the demand for consumer connections to Weihai’s district heating supply system did not materialize as projected at appraisal. However, property development accelerated dramatically after 2003, resulting in much higher heat demand. Weihai was able to nearly double the coverage of its heating system during the project period using Loan savings to meet the increased demand. Price escalations of 30% to 50% that occurred in 2003 and 2004 in key construction materials, especially steel, delayed some civil works contracts and affected contractor performance in contracts which had no provision for price escalation.

5.2 Factors generally subject to government control: Factors Affecting Implementation:

(a) Jinan Wastewater. Delay in completion of works occurred because of a failure to implement the agreed terms of the RAP for a section of the Jinan wastewater trunk sewers that overlapped a development by another agency. The subsequent delay in land acquisition delayed the project by about two years.

(b) Tariff Revisions. The extent and timing of tariff increases were largely controlled by JMC through the Price Bureau, and these decisions were influenced more by a combination of social and economic factors. Consequently, although utility revenue enhancements took place about every three to four years, their revenues requirements were not met in a timely manner.

Factors Affecting Outcome:

(a) Arresting the Depletion of Groundwater Aquifer. Despite the municipal regulations, and State Council directives of 2000 and 2004 that ban self-supply where a service is available*, some industries in Jinan have continued to use groundwater from self-supply wells. SPG did not intervene to support JWSC despite numerous requests; instead, JMC has provided JWSC an operating subsidy since 1998.

*State Council Directive No.36 (2000) states that ‘within the city supply area, no new self water supply wells will be allowed. For existing self water supply wells, measures must be implemented to reduce the abstraction rates gradually, towards the total elimination of the abstractions. State Council Directive No.36 (2004) prescribes that ‘ in addition to SD No. 36 (2000), all self supply wells must install approved water meters. If meters are not installed, water use charges will be calculated based on maximum abstraction capacity’.

(b) Direct Remittance of Wastewater Revenues. Wastewater revenues collected by JWSC are remitted to the Jinan Finance Bureau (JFB), which in turn, provides JMDC an annual budget for its operations and debt service obligations. The continuation of this arrangement is contrary to intentions at appraisal, but is expected to be rectified in the near term.

5.3 Factors generally subject to implementing agency control: (a) Contract and Procurement Management. Lack of due diligence in preparing contract variations in the water supply component and failure to follow Bank procedures resulted in expenditures of $2.5 million being ineligible for disbursement. Similarly, lack of due diligence and oversight in procurement management by YHPC resulted in a misprocurement and cancellation of $1.4 million from the Loan.

(b) Construction Planning. Weak planning and coordination of construction with municipal authorities and traffic police resulted in delays in completion of the water supply and wastewater components.

- 11 - (c) Counterpart Funds. JWSC was unable to carry out agreed additions to the distribution network under its ongoing annual program for network renewal and extensions, despite commitments made at negotiations. During implementation, the situation was remedied using Loan savings for the work.

5.4 Costs and financing: Costs. Project cost at appraisal was estimated at US$202 million (including contingencies of US$25.3 million). The total cost of the project as implemented is estimated at US$224.3 million (111% of the appraisal cost). The increase was due to higher resettlement costs and the addition of new components to utilize Loan savings of about $17 million. The cost of the original works, equipment and services was estimated at US$149.8 million, whereas the actual cost was US$134.5 million – savings of US$40.6 million.

Financing. The original Bank loan was US$95 million; US$1.4 million was canceled due to mis-procurement, leaving a net Loan amount of US$93.6 million. As of April 28, 2006, US$91.31 million had been disbursed, leaving another US$2.29 million to be canceled. The disbursement percentages for civil works, goods and services, remained unchanged during the implementation period. The borrower contributed the remaining financing.

Extension of Loan Closing Date. The closing date was extended a total of two years. The first extension from December 2003 to December 2004 allowed completion of investments under the original project; the second extension to December 2005 allowed completion of the investments financed with savings.

6. Sustainability 6.1 Rationale for sustainability rating: The project sustainability is rated likely for all components. All investments were successfully completed and are fully operational. SPG is committed to sustainable management of environmental investments through full cost recovery, and has approved periodic tariff increases for project utilities. Improved management systems have been introduced in all four utility companies supported by the project's technical assistance.

Sustainability of water supply investments has been hampered somewhat because JWSC is not able to sell about half the water available to industry. SPG has not enforced the ban on self supply water by industry, but has provided JWSC an operating subsidy since 1998. SPG has confirmed to the Bank that it will enforce the ban. Once it does so, JWSC will become profitable thus ensuring sustainability.

Sustainability of wastewater investments in Shandong Province has improved significantly with SPG's 2005 policy decision requiring all municipalities to implement minimum wastewater tariffs. The minimum tariff stipulated is about double the prevailing average tariff, which improves cost recovery and reduces deficits. In Jinan, SFB has provided annual operating subsidies to meet this deficit in the wastewater operations. These deficits would decline substantially when industries start using city water supply.

District heating companies in Weihai and Yantai implemented periodic tariff increases. They too have received operating subsidies. Prospects for Weihai are brighter, because about 40 percent of revenue is derived from the sale of excess power generated by the power plant financed under the project.

EPB has selected more sub-projects to be financed by the revolving fund. The sub-project list is under review by SFB.

- 12 - 6.2 Transition arrangement to regular operations: All utility companies under the project own and operate project-financed assets in a satisfactory manner. The latest business plans of four utility companies demonstrate a commitment to improve financial and management performance and service delivery. SPG continues to monitor their performance through various regulatory agencies using most of the indicators adopted by the project.

7. Bank and Borrower Performance Bank 7.1 Lending: The Bank’s performance in the lending phase, including identification, preparation and appraisal, is rated satisfactory. The Bank provided skilled and experienced experts through all stages of the project (see Annex 4).

Identification and Preparation. Project identification and preparation were built on Shandong Province’s priority plans for control and prevention of pollution in the Xiaoqing River basin, and the aim of addressing critical infrastructure bottlenecks. Project components focused on: pollution in the XRB; air quality in two cities; arresting depletion of groundwater in the capital city; and policy and institutional reforms. The Bank assisted the Borrower in obtaining international consultants funded by a PHRD grant. Particular attention was given to the appropriateness of technical solutions, and consistency between objectives and selected components. The Bank confirmed that the safeguards documents and fiduciary arrangements met Bank requirements.

Appraisal. The appraisal mission produced a comprehensive and high quality SAR. In accordance with Bank practice in urban environment projects, new companies were created by appraisal for wastewater and district heating, and the existing water supply company acquired a business license. The existing Jinan Water Supply Company was well run, and was financially viable at the time of appraisal. As the district heating and wastewater companies were established just before appraisal, no meaningful assessment was possible of their institutional and financial capabilities. The project therefore included technical assistance for institutional and financial strengthening tailored for all companies.

Negotiations. The following significant actions were agreed at negotiations: (a) SPG provided environmental action plans for the three worst polluting industries in the XRB, as requested by the Bank, and received assurances that they would be implemented; and (b) SPG assured that the strengthening of the distribution network for Jinan water supply would be completed by December 2000. (As mentioned in section 3.5, it might have been better to include this network in the project rather than rely on a dated covenant.)

7.2 Supervision: The Bank's supervision performance is rated satisfactory despite the high turnover of task team leaders. The frequency of missions, team composition and the intensity of support contributed to effective supervision. Delegation of procurement and safeguards review to the country office resulted in faster response and was welcomed by the Borrower. Availability of an energy expert in the Beijing Office facilitated technical supervision of the district heating components.

The task team produced detailed and informative back-to-office reports, highlighting problems and defining action plans. Safeguards, including EAs and RAPs, were monitored and supervised by experts from the Beijing office. Special efforts were made (including through intervention by the Country Director) to ensure that SPG implemented the RAP in an acceptable manner, especially in one section of the wastewater

- 13 - trunk sewer. The Bank also showed flexibility in allowing the use of Loan savings to further support achievement of the PDO.

The Bank supervised procurement matters diligently as demonstrated by (a) declaring misprocurement in Yantai and canceling the relevant amount of the loan; and (b) not accepting variations that did not conform to Bank requirements. The task team devoted continuous efforts to help SPG comply with cost recovery covenants by reviewing the financial projections of the utility companies and designing action plans.

7.3 Overall Bank performance: The Bank’s performance is rated satisfactory overall, despite the task team leader turnover. The Bank provided experienced and motivated task teams comprising engineers, district heating experts, economists, financial analysts, environmental and safeguards experts, and procurement experts over the project's life span.

Borrower 7.4 Preparation: The Borrower’s performance during preparation is rated satisfactory. The Borrower had strong ownership of the project, and was closely involved with the preparation of the pollution abatement components, and in the formulation of the water source augmentation component, which was a critical need for Jinan at the time. With support from the Project Management Office, participating agencies quickly mobilized domestic design institutes to prepare feasibility studies for the proposed components. The recruitment of international consultants, using PHRD funds, was done reasonably expeditiously. The necessary safeguards documents were also prepared satisfactorily. Shandong welcomed the technical assistance component.

7.5 Government implementation performance: The Government’s implementation performance is rated satisfactory. All municipal authorities were committed to the project throughout the project period, and provided the necessary leadership and financial support. SPPMO provided strong leadership and project coordination throughout implementation.

The Provincial Government fostered commercial operations in the water supply and district heating companies. As in many Chinese cities, the transition to commercial operations in the Jinan wastewater company was slow. The Government diligently pursued implementation of the XRB EAP, achieving impressive results. SPG could have made stronger efforts to enforce national and provincial regulations to ban self-supply (by industry) when a water supply was available.

7.6 Implementing Agency: All implementing agencies performed satisfactorily. Implementation delays were largely due to land acquisition, which was handled by other government departments. JWSC, the most experienced of all implementing agencies, completed the component in a record time of less than two years. Implementation performance of WBHPC and YHSC (two newly formed companies) was satisfactory, except for one case of mis-procurement. JMDC required a longer time to resolve technical and implementation issues, and to become comfortable with Bank procurement procedures. The procedures for appraisal, loan disbursement, monitoring implementation and evaluation arrangements for the sub-loan facility (XRBSL) were prepared well by SEPB. SPG used its powers to recover the funds through liens on budget transfers to the concerned local governments, in cases of beneficiary industries defaulting on repayments.

Overall, the performance of implementing agencies was satisfactory because of their own efforts, consultant support, and the extensive support provided by the experienced SPPMO under good leadership.

- 14 - The SPPMO coordinated project implementation. Due to the accelerated pace of construction in the water intake and associated works early in the project, contract variations that occurred were not reported until 2000. Variations to the value of about US$2.5 million were disallowed by the Bank on the grounds that Bank procurement procedures were not followed.

Safeguard Policies. SPG and implementing agencies complied with Bank’s safeguards policies; problems encountered with the implementation of resettlement in the water supply and wastewater components were satisfactorily resolved.

7.7 Overall Borrower performance: Overall, the performance of SPG (the Borrower) is rated satisfactory. SPG demonstrated strong commitment to the objectives of the project (i.e., improving highly polluted and deteriorating water resources, and ensuring their protection), through actions to prevent and control pollution in the XRB, and implemented the project in a satisfactory manner. The Shandong Provincial Government also provided excellent environmental and other project data, from its updated environmental database, which enabled the ICR to document the impressive achievements in pollution control.

8. Lessons Learned (a) Use of Country Office Staff. Transfer of Bank procurement administration to the Country Office specialists was efficient and cost-effective, as it facilitated project implementation through prompt reviews, improved communication and follow-up. With the current capacity of the Beijing Office, enhanced responsibility can be transferred.

(b) Borrower Ownership. Achievement of project objectives was greatly facilitated by the degree of ownership demonstrated by the client. Appraised project investments were part of SPG’s priority infrastructure needs, and SPG implemented the priority environmental action plan in parallel with the project. The Province’s environmental plan was tightly inter-woven, which was a strong factor in the project’s success. SPG also took ownership of the technical assistance provided under the project.

(c) Phasing of Institutional Reform. Fees charged for wastewater services need to be converted to a ‘wastewater tariff’ so that the funds collected become legal revenue of the wastewater company. At present, the wastewater fee is the legal revenue of the municipality, which in turn provides an annual budget to the wastewater company. Control and use of revenue are important steps to promote autonomy, pursue the company’s business plan, and improve services. Government commitment is a key factor to ensure the success of regulatory and institutional reform and sustainable financial operation of utility companies. A high level of engagement from the Bank is needed to secure the government commitment.

(d) Cost Estimation. As in other China urban infrastructure projects of similar vintage, costs are overestimated through mandatory use of government schedules of rates (which have proved to be 20% to 30% higher than contract awards). This issue has now been addressed in more recent projects.

(e) Public-Private Partnerships. Public-private partnerships in the form of management contracts and financial participation through sale of stock is becoming increasingly popular in the water supply and wastewater sectors. However, transactions must be transparent and based on sound regulatory frameworks. Contracts need to clearly define the responsibilities of the different parties, and the performance criteria, quality of service, and risk management.

(f) Reliance on Dated Covenants. The experience with the expansion of the Jinan water distribution

- 15 - network not being completed per the dated covenant points to the fact that works integral to the project should be included in the project, at least as reserve procurement.

9. Partner Comments (a) Borrower/implementing agency: Overall, the Borrower has concurred with the findings in this Report, and provided some editorial and data clarifications.

The Borrower, through the Shandong Province Project Management Office, has submitted its own comprehensive evaluation report, which is attached as Annex 9. The report states “The project has contributed substantially to protecting water resources, reducing air pollution, and improving sustainable environmental management practices in Shandong Province”. The Borrower observes that (a) project design was satisfactory, and presented no obstacles during implementation, and (b) heating demand projections were somewhat optimistic, and did not adequate account of economic and social uncertainties. The Borrower has rated the Bank’s performance highly satisfactory during both project preparation and implementation. The Borrower alludes, however, to the frequent change of task managers as being a problem, despite the valuable contributions made by the individuals. (b) Cofinanciers: Not applicable (c) Other partners (NGOs/private sector): Not applicable

10. Additional Information

- 16 - Annex 1. Key Performance Indicators/Log Frame Matrix

Table 1 below shows key performance indicators and project output data, comparing appraisal to actuals.

Table 1. Key Performance Indicators and Project Output/Input (Note: Actual figures through project implementation are listed in bold.)

- 17 - Key Performance Unit CY97 CY98 CY99 CY00 CY05 CY10 Indicator Target CAS Objective Reduce infrastructure Infrastructure meets bottlenecks demand

Protect the Environment Ambient quality improvements in Shandong Specific Project Development Objectives Reduced air pollution in SO2 100 90 70 30 5 5 (a) Support improvement Yantai project area from 100 62 42 54 30 5 of environmental pollution heating (% of 1995 control, including air level) TSP 100 95 75 40 10 10 quality improvements 100 53 56 66 20 10

SO2 100 100 85 40 30 30 Reduced air pollution in 92 77 54 75 40 15 Weihai (% of 1995 TSP 100 100 80 20 15 15 level) 81 65 47 48 15 15

(b) Support sustainable COD 100 70 5 water resource % ‘96 90 70 5 management in the XRB Reduced water pollution discharged to XR (c) Prevent further % of ‘96 100 100 100 100 90 90 depletion of groundwater Reduced groundwater Estimation 100 100 100 62 90 resources in Jinan extraction in Jinan % av of 100 80 50 10 10 10 (d) Support financially Reduced level of ’93-‘96 Not Not sustainable expansion of subsidies for investments available available urban environmental in urban environmental services infrastructure Project Outputs 1. Market oriented Ratio of actual tariff to Ratio 100 100 100 100 100 100 financial management and recommended cost tariffs 100 100 100 100 100 100 efficiency improvements recovery tariff have been introduced in municipal utilities 2. Expanded surface Share of JWSC’s surface % 5 5 5 30 50 50 water supply by JWSC water to total supply 5 5 5 5 70 90

3. Adequate supply of Ratio of wastewater Ratio 0 0 50 100 100 100 wastewater for the Jinan supply to wastewater 0 0 0 0 >100 100 treatment facility to capacity operate at full capacity 4. Small & medium No. of SMI (fund No. of 5 5 5 industries apply cleaner supprtd) SMI 5 5 5 5 35 All production SMI 5. A long-term action and Plan satisfactory to investment plan for Shandong Province Prepared Done Done Done Done optimal use of XR water prepared has been prepared 6. Pollutive stoves and No. of stoves & small % of 0 5 25 80 100 100 small boilers have been boilers replaced in target 0 0 30 60 100 100 replaced by district heating project area Project Components 1. Management and Achievement of planned % of 0 30 60 90 100 100 agency strengthening and activities target 0 15 30 80 100 100 training incl. studies activity

2. Jinan Water Supply Implementation progress % of ------& environt. & social target 50 98 100 aspects Actual water supply % of 0 0 0 80 100 100 from Yellow River design 0 0 0 (50% 50 100 capacity yr01) 3. Jinan Wastewater Implementation progress % of ------Interception ratio target 10 10 10 10 80 90

- 18 - Abbreviations: WS is water supply; WWT is wastewater treatment; DH is district heating. Provincial infrastructure data sources: annual statistic year books for provincial construction.

Annex 1A Table 1: Groundwater Levels in Jinan City (before and after the project) Year Ground water level (meters above sea level) 1992 26.47 1993 25.50 1994 27.53 1995 27.41 1996 27.64 1997 26.46 1998 26.43 1999 26.08 2000 24.11 2001 25.82 2002 25.50 2003 25.30 2004 29.39 2005 29.01 Note significant rise in the groundwater level since 2004.

Ground water level in Jinan

34 32 30 28 26 24 22 Meters (above sea level) 20 1990 1995 2000 2005 2010 Year

- 19 - Annex 1 B Table 1: Water Quality in Daming Lake (before and after the project) Year BOD5 COD SS mg/l mg/l mg/l 2001 9.10 71.7 - 2002 15.44 55.6 203.2 2003 9.17 64.4 87.8 2004 5.97 37.6 - 2005 (Jan-June) 6.32 37.6 -

Water quality for Daming Lake

80

70

60

50 BOD5 40

mg/l COD 30

20

10

0 2000 2001 2002 2003 2004 2005 2006 Year

- 20 - Table 2: COD and BOD Load Reduction after Operation of Jinan WWTP

Year Pollution Load Reduction (Ton/yr) BOD COD SS 1998 1623 5,662 6,752 1999 1948 6,795 8,103 2000 3247 11,325 13,505 2001 3247 11,325 13,505 2002 4222 14,724 17,556 2003 4871 16,989 20,258 2004 11070 42,559 46,574 2005 12056 58,926 53,856 Note: 2005 data refers to load reduction from Jan. to Oct.

Reduction of COD/BOD loads after operation of JWWTP

70000

60000

50000 BOD 40000 COD

Ton/yr 30000 SS 20000

10000

0 1996 1998 2000 2002 2004 2006 Year

Table 3. Jinan Wastewater Treatment Capacity Expansion Plan Year Plant Capacity 2006 JWWTP Expansion of 130,000 t/d 2007 Taitou WWTP New capacity of 200,000 t/d 2007 Yaotou Recycling Plant New capacity of 8,000 t/d 2008 Xingjihe WWTP New capacity of 200,000 t/d 2008 Dajing WWTP New capacity of 50,000 t/d Total Expansion 588,000 t/d

- 21 - Annex 1C Weihai and Yantai Air Quality Data

Table 1: Number of Stoves and Small Boilers Discontinued in Weihai and Yantai Boiler-Stove Type Yantai City YHSC Weihai WBHPC Service Service Area Area

Industrial/residential heating Boilers (set) SAR 247 100 Actual (Nov. 2005) 247 100

Residential heating stoves (set) SAR 64,000 18,000 Actual (Nov. 2005) 64,000 18,000

Note: Yantai and Weihai municipal regulations prohibit installation of individual steam, district heating and cooling systems in new buildings in areas serviced by YHSC and WBHPC respectively.

Table 2: Yantai Ambient Air Quality (1997-2004) mg/m3 mg/m3 mg/m3 Reduction %

SO2 NO2 TSP SO2 NO2 TSP 1997 0.156 0.034 0.289 100 100 100 1998 0.096 0.035 0.153 62 103 53 1999 0.066 0.028 0.163 42 82 56 2000 0.085 0.036 0.191 54 106 66 2001 0.061 0.028 0.089 39 82 31 2002 0.051 0.037 0.068 33 109 24 2003 0.092 0.038 0.069 59 112 24 2004 0.054 0.032 0.068 35 94 24

- 22 - Chart: Yantai Ambient Air Quality (1997-2004)

Yantai City Ambient Air Quality from 1997 to 2004

0.35 0.3 0.25

SO2 0.2 NO2 mg/m3 0.15 TSP 0.1 0.05 0 1996 1998 2000 2002 2004 2006 Year

Table 3: Weihai Ambient Air Quality (1996-2004) (Percent of 1996 Levels)

SO2 NO2 TSP Reduction % mg/m3 mg/m3 mg/m3 SO2 NO2 TSP 1996 0.013 0.01 0.118 100 100 100 1997 0.012 0.009 0.096 8 10 19 1998 0.01 0.008 0.077 23 20 35 1999 0.007 0.008 0.056 46 20 53 2000 0.01 0.01 0.057 22 0 52 2001 0.013 0.009 0.028 0 10 76 2002 0.008 0.008 0.023 38 20 80 2003 0.007 0.008 0.019 46 20 84 2004 0.006 0.006 0.018 54 40 85

- 23 - Chart: Weihai Ambient Air Quality (1996-2004)

Weihai CIty Ambient Air Quality

0.14 0.12 0.1 SO2 0.08 NO2 mg/l 0.06 TSP 0.04 0.02 0 1994 1996 1998 2000 2002 2004 2006 Year

Table 4: Provincial Ambient Air Quality (1996-2004) SO2 NO2 TSP SO2 NO2 TSP mg/m3 mg/m3 mg/m3 % % % 1996 94 34 321 1997 83 34 297 100 100 100 1998 70 30 295 16 12 1 1999 62 34 276 25 N/A 7 2000 47 29 233 43 15 22 2003 46 31 100 45 9 66 2004 52 32 97 37 6 67

- 24 - Chart: Provincial Ambient Air Quality (1996-2004)

Provincial Annual Average Ambient Air Quality

350

300

250

200 SO2 NO2 ug/l 150 TSP 100

50

0 1994 1996 1998 2000 2002 2004 2006 Year

- 25 - Annex 1D

Xiaoqing River Environmental Action Plan Implementation

The Shandong Xiaoqing River Basin Water Pollution Prevention Control Regulations were formulated in 1995 to address serious environmental pollution in the Xiaoqing River. The Xiaoqing River Basin Commission was formed to implement the pollution control program. The plan includes environmental mitigation investments totaling about Yuan 7.9 billion (about US$1.0 billion) up to 2010.

SPG has a comprehensive policy for pollution prevention and control in the Xiaoqing River Basin (XRB) that includes increased municipal wastewater treatment, measures for pollution load reduction from its worst polluting industries, and mass-based pollution load targets for the Xiaoqing River to be achieved in 2005 and 2010. Regulations promulgated by the Xiaoqing River Basin Commission require: phased closure of paper mills of capacities up to 20,000 tons/year; bans on the use of certain raw materials for paper making; a reduction of direct discharge to XR by paper mills; relocation of specified polluting industries; and the adoption of wastewater recycling by all enterprises to specified targets. The maximum permissible pollution loading targets for the XR are: (a) COD load 150 mg/l in 2005 for main river (already realized based on monitoring data); (b) COD load of 80 mg/l in 2005 in tributary rivers; and (c) COD of 40 mg/l in all main and tributary rivers by 2010.

Concurrent with increased municipal wastewater treatment, SPG's strategy included: (a) reducing pollution discharges from the worst polluters, e.g., paper, chemical and steel plants, through gradual reduction and/or discontinuing use of straw and waste paper as the source for paper-making; (b) closing small capacity paper mills and clean production respectively; (c) suspending production when targets are not met; (d) requiring all industries to carry out clean technology audits; (e) relocating specified industries; and (f) closing down highly polluting industries that fail to meet specified targets.

Since 1997, 13 municipal wastewater treatment plants, with a total capacity of 1,110,000 m3/day, have been completed in five municipalities in the XRB. This is in addition to the two plants existing at that time (with total capacity of 350,000 m3/d). Three more treatment plants, with a total capacity of 80,000 m3/d, are currently under construction in XRB towns.

Action taken for industrial pollution control included: (a) closure of 37 paper mills of production capacity less than 5000t/year (since 1997); and (b) closure in 2005, of 41 paper mills of a capacity less than 20,000 t/year using waste paper for paper-making.

Pollution discharges from the three worst polluters named in the Agreed Minutes of Loan Negotiations (i.e. Jinan Iron and Steel Group, Qingzhou Paper Making Company Limited and Shouguang Yongli Pulp Making Company) have been addressed. Good progress has been made at the steel plant through adoption of clean technology, improved environmental management and reduction in energy used. In 2005, the plant received an environment-friendly enterprise award. Prior to the issuance of the State Council directive, SP had already introduced the requirement for all enterprises to obtain clean technology audits.

Ongoing plans for industrial pollution control include: (a) reduction of direct discharge to XR by 50 % by end-2007 by five paper mills using straw as raw material; (b) preparation by end-2005, of comprehensive pollution reduction plans by all municipalities; (c) relocation by end-2006, of the Yuxin Chemical plant and

- 26 - the straw-based paper unit of the Guangrao Paper plant; and (d) adoption of wastewater recycling by all enterprises – 50 percent by end-2007, and 100 percent 2010.

Table 1: Water Quality Data for Xiaoqing River Basin (1996-2004) (COD mg/l)) Lu-Li-Zhuang Jinan City Bingzhou City Weifang City (waterhead) Huan Xiang Fuqiao Houxing Dian 1996 16.11 192.31 146.96 114.83 1997 19.23 149.13 84.78 122.98 2001 16.68 113.18 113.00 107.00 2002 114.63 169.33 96.83 2003 21.61 97.28 151.50 87.00 2004 19.53 61.97 103.70 59.25 Note: In the upstream section of the Xiaoqing River, at Lu-Li-Zhuang Transect, the COD level remains good and steady, indicating stable water resource protection. The COD levels downstream of the river (from Huan Xiang Dian Transect in Jinan City to Houxing Transect in Weifang City) have been significantly reduced since 2003 due to the project interventions and Shandong Government’s Environmental Pollution Control Programs.

250.00 200.00 Lu-Li-Zhuang (waterhead) 150.00 Jinnan City 100.00 HuanXiangDian

COD (mg/l) 50.00 Bingzhou City Fuqiao 0.00 Weifang City 1994 1996 1998 2000 2002 2004 2006 Houxing Year

Table 2: Water Quality Data for Xiaoqing River Basin (1996-2004) (BOD mg/l)) Lu-Li-Zhuang Jinan City Bingzhou City Weifang City (waterhead) Huan Xiang Fuqiao Houxing Dian 1996 1.62 66.63 10.60 40.57 1997 2.28 47.02 29.22 48.98 2001 0.90 15.50 39.03 47.78 2002 3.08 46.27 64.83 44.75 2003 1.67 23.70 28.17 38.55 2004 1.54 12.71 30.70 24.94 Note: In the upstream section of Xiaoqing River, (at Lu-Li-Zhuang Transect), the BOD level remains good and steady. The BOD levels downstream (from Huan Xiang Dian Transect in Jinan City to Houxing Transect in Weifang City) have been significantly reduced since 2003 due to the same reasons stated in Table 1.

- 27 - Water Quality Data for Xiaoqing River Basin From 1996 to 2004

70 60 Lu-Li-Zhuang 50 (waterhead) 40 Jinnan City 30 HuanXiangDian

BOD (mg/l) 20 Bingzhou City 10 Fuqiao 0 Weifang City 1994 1996 1998 2000 2002 2004 2006 Houxing Year

Table 3: Water Quality Data for Xiaoqing River Basin (1996-2004) (NH4_N mg/l)

Lu-Li-Zhuang Jinan City Bingzhou City Weifang City (waterhead) Huan Xiang Fuqiao Houxing Dian 1996 0.66 14.09 7.78 7.47 1997 0.33 19.60 5.38 10.05 2001 0.95 21.97 20.50 12.82 2002 0.11 27.29 20.27 11.51 2003 0.16 24.88 19.62 9.22 2004 0.36 13.39 14.73 7.85 Note: The NH4 level in the Xiaoqing River remains good and steady. The NH4 levels downstream (from HuanXiangDian Transact in Jinan City to Houxing Transect in Weifang City) have been significantly reduced since 2003 due to the same reasons stated in Table 1.

- 28 - Water Quality Data for Xiaoqing River Basin From 1996 to 2004

30

25 Lu-Li-Zhuang 20 (waterhead) 15 Jinnan City HuanXiangDian 10

NH4_N (mg/l) Bingzhou City 5 Fuqiao 0 Weifang City 1994 1996 1998 2000 2002 2004 2006 Houxing Year

Table 4: Estimated Impacts of the Xiaoqing River Subloan Investments (Up to Nov 2004, for 23 subprojects)

Impact 1997 (Base Yr) Nov. 2004 Wastewater reduction 0 ton/yr 8.85 million ton/yr COD Load reduction 0 ton/yr 69,000 ton/yr Economic enhancement (savings through 0 Yuan Yuan 103.86 million water, energy conservation and CDM) Social Impacts (environmental awareness, No base for Significant for the CDM promotion and local employment) comparison subprojects, moderate for total local economy

Table 5: Pollutant Reduction in Three Major Polluters (Jinan Iron and Steel Plant, Qingzhou Paper Mill, and Weifang Yongli Paper Mill)

Enterprise COD discharge COD discharge in Annual Note at Appraisal 2005 COD (Ton/yr) (Ton/yr) Reduction (Ton/yr) Jinan Iron and 1,376 1,374 2 The plant capacity has been Steel Plant increased from 2.15 million ton/yr in 1997 to 6.87 million ton/yr in 2004. The unit production discharge of COD has been reduced from 0.64 to 0.2 kg per ton of steel.

- 29 - Qingzhou Paper 3,000 580 2,420 The plant has demolished the old Mill pulp production process, thereby eliminating a major pollution source. Currently, it uses imported pulp for paper production. Shandong Data not available Data is not Data not The company has modified Chenming Paper available. available production process and taken Group Company Currently, the mitigation measures to reduce Ltd. (formally plant pollutant pollution, which are: installation Yongli Paper Mill) discharge meet of 300 ton/d incineration plant, ‘Shandong caustic soda reuse system; and a Provincial wastewater treatment plant standard for 100,000 m3/day (total) capacity. paper industry wastewater discharges’

Table 6: New Municipal Wastewater Treatment Plants in Xiaoqing River Basin Capacity Investment

No. Municipality Wastewater Treatment Plant (WWTP) m3/day Yuan million Year of completion 1 Jinan WWTP 220,000 305 2000 2 Jinan Zhanqiou WWTP 25,000 36 2005 3 Zhangdian WWTP 200,000 360 1992 4 Lingzhi Wuhe WWTP 20,000 20 2002 5 Lingzhi Qidu WWTP 30,000 25.3 2003 6 Poshan District WWTP 50,000 52 2004 7 Zhichuan District WWTP 30,000 49.6 2004 8 Zhouchun District WWTP 40,000 35 2005 9 Zhibo Gaoqing County WWTP 30,000 61.6 2005

10 Dongying Guangrao County WWTP 25,000 24 2004 11 Qingzhou WWTP 30,000 16 1997 12 Weifang Shouguang WWTP 120,000 112 1998 13 Boxing County WWTP 30,000 44.2 2003 14 Zhouping County WWTP 40,000 53.9 2004 Zhouping County WWTP 15 Bingzhou Expansion 20,000 37.3 2005 Total 910,000 1,231.90

- 30 - Annex 2. Project Costs and Financing

Project Cost by Component (US$ million)

Project Cost by Component Appraisal Actual/Latest Percentage of Estimate Estimate Appraisal US$ million US$ million Jinan Water Supply Civil Works 36.8 45.9 124.7 Goods 3.7 12.5 337.8 Jinan Wastewater Civil Works 25.0 21.2 84.8 Goods 1.8 1.7 94.4 Weihai District Heating Civil Works 10.0 16.2 162.0 Goods 25.2 20.8 82.5 Yantai District Heating Civil Works 5.2 23.6 453.8 Goods 35.8 20.6 57.5 Env. Pollution Prevention & Control /c 10.0 10.0 100.0 Institutional Strengthening & Training 3.9 2.8 76.9 Construction Supervision Services 2.4 2.2 91.7 Land Acquisition & Resettlement 29.2 33.9 116.1 Administration & Project Management 13.0 12.7 97.7 Project Total 202.0 224.4 Percent of total 100.0 111 111

- 31 - Project Costs by Procurement Arrangements (Latest Estimate) (US$ million)

Procurement Method Project Cost by Component ICB NCB Other /a NBF /b Total Jinan Water Supply Civil Works 21.8 20.6 0.0 3.5 45.9 (8.7) (7.1) (0.0) (0.0) (15.8) Goods 11.9 0.6 0.0 0.0 12.5 (11.9) (0.4) (0.0) (0.0) (12.3) Jinan Wastewater Civil Works 9.4 11.5 0.0 0.3 21.2 (3.4) (4.1) (0.0) (0.0) (7.5) Goods 1.5 0.2 0.0 0.0 1.7 (1.5) (0.2) (0.0) (0.0) (1.7) Weihai District Heating Civil Works 0.0 12.8 0.0 3.4 16.2 (0.0) (4.1) (0.0) (0.0) (4.1) Goods 19.4 0.03 0.06 1.3 20.8 (19.7) (0.14) (0.06) (0.0) (19.9) Yantai District Heating Civil Works 0.0 9.1 0.0 14.5 23.6 (0.0) (1.6) (0.0) (0.0) (1.6) Goods 18.9 0.0 0.2 1.4 20.6 (18.5) (0.0) (0.0) (0.0) (18.5) Env. Pollution Prevention & Control /c - - (5.0) 5.0 10 Institutional Strengthening & Training - (2.8) 0.0 2.8 Construction Supervision Services - (2.0) 0.2 2.2 Land Acquisition & Resettlement - - - 33.9 33.9 Administration & Project Management 12.7 12.7 Total 83.0 54.8 10.1 76.4 224.3 (63.8) (17.7) (9.9) (0.0) (91.3)

Note: Figures in parenthesis are amounts financed by the Bank /a Other procurement methods include those under XRBSL, shopping (national and international), consultant services (recruited in accordance with the Bank’s Guidelines) and training. /b NBF = Non Bank-financed. /c The Environmental Pollution Control component was disbursed through sub-loans of Shandong Province’s XRBSL facility.

- 32 - Project Financing by Component (US$ million) Project Cost by Component Appraisal Actual/Latest Percentage of Estimate Estimate Appraisal Shandong Bank Shandong Bank Shandong Bank Jinan Water Supply Civil Works 22.9 13.9 30.1 15.8 130.6 113.7 Goods 2.2 1.5 0.2 12.3 9.5 820.3 Jinan Wastewater Civil Works 15.0 10.0 13.7 7.5 91.5 75.0 Goods 0.6 1.2 0.0 1.7 0.5 144.8 Weihai District Heating Civil Works 6.0 4.0 12.1 4.1 186.8 102 Goods 4.6 20.6 1.0 19.9 36.4 96.8 Yantai District Heating Civil Works 3.1 2.1 22.0 1.6 653.3 76.1 Goods 5.4 30.4 2.1 18.5 37.1 61.0 Env. Pollution Prevention & Control /c 5.0 5.0 5.0 5.0 100 100 Institutional Strengthening & Training 0.0 3.9 0.0 2.6 66.9 Construction Supervision Services 0.0 2.4 0.2 2.0 83.3 Land Acquisition & Resettlement 29.2 0.0 33.9 0.0 116.1 Administration & Project Management 13.0 0.0 12.7 0.0 97.4 Project Total 107.0 95.0 133.0 91.3 124.2 96.0 Percent of total 53.0 47.0

- 33 - Annex 3. Economic Costs and Benefits The economic analysis of the project covers four components: (a) Jinan water supply; (b) Jinan wastewater supply; (c) Weihai district heating; and (d) Yantai district heating. The economic analysis of these four components represents 70% of the total project costs. The economic analysis is based on the evaluation of the costs and benefits of the project components from the summary of updated cost estimates provided by SPPMO. The assumptions used for the ICR analysis are the same as in the SAR, Annex 15. An overall economic rate of return for the entire project was not calculated at appraisal. ERRs were calculated only for those components, which rendered appropriate data to monetize and quantify economic benefit streams. For the wastewater treatment component data was not readily available and economic benefits were not quantified.

During implementation, all four components were modified and the economic analysis reflects the final costs estimates of the project. Table 1 below shows the component costs increase at appraisal and at completion.

Table 1. Component Costs at Appraisal and Completion SAR ICR Componet % of all Actual Costs Cost % of all Cost ($M) costs ($M) Overrun Costs Jinan Water Supply $40.5 20% $47.00 16% 21% Jinan Wastwater $26.8 13% $22.60 -16% 10% Weihai District Heating $35.2 17% $37.00 5% 17% Yantai District Heating $41.0 20% $42.80 4% 19%

Jinan Water Supply

The objective of the Jinan water supply component is to halt groundwater depletion while meeting the increasing water demand from Jinan's urban expansion. The planned component was implemented between 1998 and 2001. Additional works, using loan savings, were carried out between 2003 and 2005 expanding the distribution network by 25 km. Economic analysis at appraisal showed a net present value of Y147 million and an economic rate of return of 18 percent. Using the same method, the immediate net benefit to the serviced population of about 1 million were recalculated after completion as Y58 million with an ERR of 14 percent (Table 2). The drop in net benefits and economic rate of return is due to the 16% cost overrun.

Jinan Wastewater

The objective of the Jinan wastewater component is to provide sewerage network to the wastewater treatment plant (WWTP) and enhance collection to reach full capacity of 220,000 m3/day. The component was successfully implemented and the system currently employs a ceiling capacity of WWTP with benefits accruing to 1 million people. Due to the nature of the project, benefits on the downstream environment are expected and should result in improvements in the living conditions and health of communities living downstream. However, no quantitative cost benefit analysis was carried out at appraisal.

- 34 - Table 2. Costs and Benefit at Appraisal and ICR: ERR (%) and NPV (@12%, Y Million) Appraisal ICR Components Method Options NPV ERR NPV ERR Jinan Water Supply Least-Cost 146.80 18% 57.76 14% Jinan Wastewater Cost Effective na na na na Excluding envir. Benefits 415.27 31% 425.42 31% Weihai District Heating Least-Cost Full costs analysis 548.97 37% 566.40 37% Excluding envir. Benefits 535.35 66% 559.08 65% Yantai District Heating Least-Cost Full costs analysis 657.26 71% 685.01 70%

Weihai District Heating

The objective of the Weihai district heating component was to reduce air pollution by replacing inefficient small boilers and stoves with high efficiency district heating networks. The additional 25 MWe power generation and 130 t/h heating supply system, using loan savings, were implemented between 2004 and 2005. The component used least-cost alternatives to determine the social costs and benefits and opted for the complete replacement option (vs. partial replacement “small boilers only”). The ICR recalculation of the economic benefits and ERR shows rates similar to those calculated at appraisal i.e. 31% and 37% for the two estimated options.

Yantai District Heating

The objective of the Yantai district heating component was to reduce air pollution by replacing inefficient small boilers and household stoves with district heating networks. The heating supply system was implemented between 1998 and 2005, including the additional components, which were carried out using loan savings. The project has increased Yantai municipality’s centralized heating supply coverage from 30 percent in 1999 to over 85 percent in 2005. The component used least-cost alternatives to estimate costs and benefits. Due to slightly higher than appraised capital costs and assuming all other parameters to be close to appraisal values, the economic rate of return was re-calculated at 65 % without air pollution benefits and at 70% including environmental benefits.

The Borrower has also stated that non-quantifiable additional environmental benefits were achieved from the district heating components. Intangible costs and benefits were credited for industrial pollution control, institutional strengthening and increased sustainability of the heating operation.

- 35 - Annex 4. Bank Inputs (a) Missions: Stage of Project Cycle No. of Persons and Specialty Performance Rating (e.g. 2 Economists, 1 FMS, etc.) Implementation Development Month/Year Count Specialty Progress Objective Identification/Preparation 05/21/96 10 Municipal Engineer Sanitary Engineer Dist. Heating Spec. Institutional Spec. Safeguards Spec. – 4 Ind. Pollut. Spec. – 2 07/17/96 7 Municipal Engineer Sanitary Engineer -2 Water Engineer Financial Analyst Inst. /Fin. Spec. Economist 09/16/96 10 Municipal Engineer Sanitary Engineer Dist. Heating Spec. Institutional Spec. Safeguards Spec. – 2 Financial Analysts -2 Economist Treatment Spec

Appraisal/Negotiation 01/20/97 9 Municipal Engineer Sanitary Engineer Dist. Heating Spec. Safeguards Spec. – 4 Financial Analysts Economist Supervision 12/07/97 6 Sanitary Engineer, S S Municipal Engineer, Financial Analyst, Training Spec., Dist. Heating Spec., Sanitary Engineer 05/25/98 2 Sanitary Engineer, S S Dist. Heating Spec. 01/11/99 7 Financial Analyst, U S Dist. Heating Spec. (2), Resettlement Spec. (3), Municipal Engineer 09/13/99 6 Municipal Engineer, U S Dist. heating Spec., Resettlement Spec. (2), Municipal Engineer,

- 36 - Financial Analyst 09/11/00 6 Municipal Engineer, U S Resettlement Spec.(2), Water Engineer, Financial Analyst Dist. Heating Spec. 04/23/01 3 Water Engineer, S S Financial Analyst, Dist. Heating Spec. 10/29/01 3 Financial Analyst, S S Dist. Heating Spec., Municipal Engineer 04/14/02 5 Financial Analyst, U S Dist. Heating Spec., Resettlement Spec., Water Engineer, Procurement Spec. 10/14/02 5 Financial Analyst, U S Municipal Engineer Dist. Heating Spec., Water Engineer, Procurement Spec. 03/03 n/a (Mission cancelled due to SARS) 11/21/03 5 Financial Analyst, S S Municipal Engineer, Energy Specialist, Environ. Engineer 06/14/04 5 Financial Analyst, S S Municipal Engineer, Dist. Heating Spec., Water Engineer, Resettlement Spec. 11/11/04 3 Municipal Engineer, S S Water Engineer, Procurement Spec. ICR 11/16/05 -1/12/06 3 Municipal Engineer, S S Financial Analyst, Dist. Heating Spec.

(b) Staff:

Stage of Project Cycle Actual/Latest Estimate No. Staff weeks US$ ('000) Identification/Preparation 83.0 350.0 Appraisal/Negotiation 21.2 63.8 Supervision 69.2 171.5 ICR 7.75 28.06 Total 181.15 613.36

- 37 - Annex 5. Ratings for Achievement of Objectives/Outputs of Components (H=High, SU=Substantial, M=Modest, N=Negligible, NA=Not Applicable) Rating Macro policies H SU M N NA Sector Policies H SU M N NA Physical H SU M N NA Financial H SU M N NA Institutional Development H SU M N NA Environmental H SU M N NA

Social Poverty Reduction H SU M N NA Gender H SU M N NA Other (Please specify) H SU M N NA Private sector development H SU M N NA Public sector management H SU M N NA Other (Please specify) H SU M N NA

- 38 - Annex 6. Ratings of Bank and Borrower Performance (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory)

6.1 Bank performance Rating Lending HS S U HU Supervision HS S U HU Overall HS S U HU

6.2 Borrower performance Rating Preparation HS S U HU Government implementation performance HS S U HU Implementation agency performance HS S U HU Overall HS S U HU

- 39 - Annex 7. List of Supporting Documents 1. The World Bank: Staff Appraisal Report: Shandong Environment Project dated September 26, 1997, Report No. 16065-CHA. 2. The World Bank: Shandong Environmental Project - Loan Agreement between China and the International Bank for Reconstruction and Development, Feb. 4, 1998 3. The World Bank: Shandong Environmental Project - Project Agreement between Shandong Province and the International Bank for Reconstruction and Development, Feb. 4, 1998 4. Shandong Province Project Management Office: Shandong Environmental Project - Quarterly Progress Reports 5. Detailed financial projections for all utilities, prepared for a period of about 7 years by each implementing agency. 6. The World Bank: Preparation and supervision mission Aide Memoires, back-to-office reports and PSRs from 1996 to December 2005.

- 40 - Additional Annex 8. Land Acquisition and Resettlement

Overall, land acquisition and resettlement were implemented satisfactorily (except in one case) and strictly in accordance with the detailed RAPs. RAPs conforming to Bank and Government guidelines were also prepared for the additional components included in the project. The table below provides a summary of the project affected people and their land lost.

Impact Category Affected People Land Loss Agricultural Land 14,050 15,581 Mu Houses 1,729 168 Mu Shops, Institutions & Enterprises 274 14 Mu Other Roads 227 Mu Total 1,6053 15990 Mu

The one resettlement exception related to Jinan Municipality’s decision to depart from the agreed RAP in respect of one section of a main trunk sewer. This resettlement issue arose because the construction of the Xiaoqinghe Beilu and Xiaoqinghe Nanlu trunk sewers were combined with the non-Bank financed Provincial Comprehensive Control Scheme of the Xiaoqinghe River. In 1996, Jinan Municipal Government issued a specific directive reducing compensation payable to affected households and businesses in these areas. Nonpayment of compensation in accordance with the RAP in the areas of the above trunk sewers, even though they did overlap with the provincial development project, constituted a major breach of the Bank’s safeguard policies. The Bank alerted Shandong Province (SP) that this practice was not in line with its resettlement safeguard policies and requested urgent action to remedy the serious situation.

Various alternative solutions proposed by the Borrower were discussed by the Bank, Shandong Provincial and Jinan Municipal Governments and the Ministry of Finance (MOF). Eventually, agreement was reached on: (a) the conversion of land use from wasteland and house plot land to commercial use and a waiver of fees applicable to such conversion was accepted as reasonable in-kind compensation for land acquired under the JMDC component; (b) compensation payments to the state-owned enterprises in accordance with the RAP, the provision of new shop premises, plots for construction of shops, shop rental premises, waiving of management fees for four years, and assistance in obtaining business licenses for shop owners was accepted as reasonable in-kind compensation to the shop owners affected by the project; and (c) evidence presented that the affected villages were satisfied with the financial arrangements for the relocation housing.

The Bank monitored implementation of the agreement until it was satisfied that the final agreement was fully and correctly implemented. Follow-up actions were then carried out by Shandong to implement the agreed compensation measures. It took much longer than expected to fully resolve the issue (about two years) because the conversion of land to commercial use required approval of the State Council. Shandong completed the compensation payments and other measures satisfactorily in early 2003. All documentary evidence on the implementation of resettlement, satisfactory to the Bank, was provided in July 2003.

- 41 - Additional Annex 9. Borrower’s Implementation Completion Report

Assessment of development objectives and design and of quality at entry

1. Original objectives The specific objectives of the Shandong Environment Project (SEP) were to: (a) strengthen policies, regulations and institutional arrangements for municipal water, wastewater, and district heating, and environmental pollution prevention and control (b) expand surface water supply to Jinan to prevent further depletion of groundwater aquifers (c) facilitate sustainable management of investments in pollution control and municipally-provided urban environmental services (d) arrange updating of the information database about water quality and management in Xiaoqing River Basin (XRB). Full details of and background to these objectives are set out in the Staff Appraisal Report (SAR) dated 26 September 1997 (Report No. 16065-CHA).

2. Revised objectives The original objectives remain valid and no revision has been made during the implementation period.

3. Original components The original components were described in the SAR including 1) water supply management and wastewater management in Jinan Municipality 2) combined power generation and district heating supply in Weihai 3) municipal district heating in Yantai 4) environmental pollution prevention and control 5) institutional strengthening and training.

4. Revised components The original project components remained unchanged during the implementation. However, there have been minor changes in the design aspect for some components, in response to sound technical requirements. There were also additions to the detailed scope of works to make use of loan savings. These changes were discussed with the World Bank and agreed solutions were documented in writing either in the aide memoires or separately. (a) Jinan water supply component The Yellow River crossing was originally designed as a DN2000 steel pipe as documented in the SAR. During the implementation stage, the design was further fine-tuned and the pipe diameter was reduced to DN1800; this was considered adequate to meet the required design capacity. The transmission pipeline was originally planned as a National Competitive Bidding (NCB) civil works contract including the supply and installation of DN1800–2000 prestressed concrete pipes. With

- 42 - approval from the World Bank, the contract was split into two contract packages: one International Competitive Bidding (ICB) goods contract for pipe supply, and one NCB civil works contract for pipeline installation and associated civil works. In addition, the concrete pipes were changed to steel pipes in the ICB goods contract, with the approval of the World Bank. (b) Jinan wastewater component Approximately 3 km of sewer in Bei-Yuan Road was deleted from the scope of this component. This was due to it already being constructed in a road project by others, before the SEP construction commenced in this section. After approval was gained from the World Bank, construction of pavement on Ji-Luo Road and Xiao-Qing-He-Bei Road (approximately 6 km in total) was added to the project and completed, together with the sewer construction on the same section. Contract JWW/21.1 – sewer cleaning equipment (ICB Goods) was cancelled, with approval from the World Bank, on the grounds that the proposed imported pipe cleaning vehicle was expensive and not considered cost-effective; existing alternative equipment was considered adequate for the intended functions. (c) Weihai District heating supply component The original plan in the SAR was to build a system with 2x12 MW double-extraction turbo-generator sets and 3x75 t/h fluidized-bed boilers. During the implementation stage and after approval by the domestic government and the World Bank, it was decided to expand the system, using loan savings, by adding one 25 MW generator set and one 130 t/h fluidized-bed boiler. The heating network has also been expanded accordingly, using the loan savings. The completed system can cover a much larger heating supply area and thus further increase the environmental benefit. The number of users of district heating has been increasing substantially over the past few years. To be more efficient in terms of operation and maintenance, the 10 heat exchanger stations planned in the SAR were changed to 241 fully automatic heat exchanger units (including the system which was expanded using loan savings). The detailed design incorporated innovative use of connection boxes for individual user connections, which will provide great savings, through better operating efficiency and extended life expectancy of the system. (d) Yantai District heating supply component The original preliminary design recommended a peak boiler plant with 4x29 MW hot water boilers; these were endorsed by the SAR, together with associated equipment and facilities. The boiler plant was intended to provide additional heating at peak load condition, at which point the existing heating source (from Yantai Bo-Hai Thermal Power Co. Ltd) was inadequate to meet the demand. It must be mentioned that this solution was criticized by some members of the expert panel during review of the preliminary design, a compulsory process required by the domestic government. However, it was adopted because there was no better option at the time. During the detailed design at implementation stage, further discussion and negotiations were held with the heating source provider (Yantai Bo-Hai Thermal Power Co. Ltd) which agreed to carry out modifications and improvements to its existing facilities so that a reliable heat source would be available to enable the heating network to meet the peak heating demand. This has led to the deletion from the original design of the peak boiler plant which became unnecessary as a result of the heating source provider’s modifications. The change resulted not only in a better technical solution with an enhanced environmental benefit, but also in savings in capital investment for the borrower. To meet the demand of the increasing numbers of heating users, the heating network was expanded using loan savings. The expansion included the construction of approximately 10 km of main pipeline,

- 43 - 10 km of branch pipeline and eight heat exchanger stations covering an area of 1.5 million m2. There was a mis-procurement case for Yantai (the only one for the whole project) on contract package YDH/23.1-1 which involved the supply of communication and controls equipment for the heating network. This resulted in the cancellation of US$1.4 million from the loan. This happened because there were disagreements between the Implementing Agency and the contractor regarding some contract conditions, and the contract was not signed after bid opening. Although this is unfortunate, it had no impact on the implementation of the heating system, as the equipment was eventually procured and installed using the counterpart financing. (e) Xiao-Qing River Basin environmental pollution prevention and control During project implementation, the Provincial Environmental Protection Bureau (EPB) (in coordination with the Provincial Financial Bureau and the Provincial Development and Reform Commission), developed detailed implementation procedures for use by XRB Environmental Pollution Prevention & Control Revolving Fund. Local municipal governments were actively involved in the project selection and decision-making processes to ensure quality. After careful analysis, the number of small enterprises to receive the fund distribution was revised from 42 at the appraisal, to 32 during actual implementation. (f) Institutional strengthening and training No change was made to the original scope and all tasks have been successfully implemented with assistance from the international consultant. 5. Quality at entry Project preparation, including scope formation, design and other aspects, has been proven to be satisfactory, and has caused no obstacle for successful implementation of the project. Changes to the components and addition of new projects using loan savings as described above, have neither caused restructuring of the project, nor necessitated change to the implementation strategy for achieving the project objectives. Predictions for heating demand in areas to be developed proved to be a little optimistic. In some areas, for both Yantai and Weihai, heating networks were constructed but building development (both residential and industrial) lagged behind. This resulted in less revenue generation for the heating companies. However, this is closely related to economic development in the borrower’s country, as heating demand in Weihai has been increasing rapidly since 2003 (one to two years after the originally planned components were completed). Thus a more thorough analysis could have been carried out. More importantly, some flexibility should be included in the implementation strategy in future, in order to tackle the uncertainty associated with the current dynamic economic and social development in the borrower’s country.

Achievements of objectives and outputs

6. Outcome/Achievements of objectives The project has contributed substantially to protecting water resources, reducing air pollution, and improving sustainable environmental management practices in Shandong Province. Completion of the planned wastewater collection system in Jinan enabled the Jinan Wastewater Treatment Plant to function to its design capacity and significantly reduced the pollution loads to the local watercourses. The successful commissioning of the Jinan water supply component has greatly improved Jinan Municipality’s water supply system, resulting in a significant reduction in the extraction of ground water. One of the obvious benefits is that the famous Bao-Tu Spring in Jinan has resumed flowing in

- 44 - the last few years and the groundwater level has risen a number of metres. The Yantai component has built one of the most advanced district heating systems in China, replacing over 300 small coal burning heat supply boilers and over 60 000 residential coal burning stoves. This has resulted in a significant improvement in air quality in Yantai Municipality. The successful completion of the Weihai combined power and heating system has permitted centralized heating services to be provided to a large number of users in the high-tech economic development zone and the number of subscriptions to the heating system has been continuously increasing. Measurement records show improvement in the air quality in the area and this positive impact has been praised by both local government and residents. The Xiao-Qing River Basin component has made a noticeable contribution to improved environmental infrastructure management for sustainable expansion of environmental services. The management practice of all agencies involved in implementation has improved through their adoption of the institutional strengthening and training package. 7. Output by components l Jinan wastewater (US$36.5 million SAR; US$27.98 million December 2005) Successfully implemented between 1999 and 2005. Now collecting sewage up to 370,000 m3/d for the catchment, with about 220,000 m3/d flowing to Jinan WWTP for treatment. The sewage system provides services to an area of 108 km2. l Jinan water supply (US$62.6 million SAR; US$89.61 million December 2005) The originally planned component was successfully implemented between 1998 and 2001, and the additional works, using loan savings, were implemented between 2003 and 2005. The water supply system now has a storage capacity of 46 million m3 raw water taken from the Yellow River and is supplying 440 000 m3/d raw water to the existing water treatment plants in Jinan. l Weihai District heating (US$42.9 million SAR; US$43.18 million December 2005) The originally planned 24 MW power generation and 3x75 t/h heating supply capacity were successfully implemented between 1998 and 2001. The additional 25 MW power generation and 130 t/h heating supply system, using loan savings, were implemented between 2004 and 2005. l Yantai District heating (US$6.1 million SAR; US$47.16 million December 2005) The heating supply system was implemented between 1998 and 2005, including the additional components which used loan savings. The heating network, with fully automated computer-based control system, now supplies heating to 85 000 families and over 1000 institutional users covering a gross floor area of approximately 8.8 million m2. The project has increased Yantai Municipality’s centralized heating supply coverage from 30 per cent in 1999 to over 85 per cent in 2005. l Xiao-Qing River Basin environmental pollution control sub-loan facility (US$10 million SAR; US$10 million December 2005) The XRB Environmental Pollution Prevention & Control Revolving Fund has been satisfactorily implemented. Thirty-two small industry enterprises have received fund distributions to control their industrial pollution.

- 45 - In addition, the Shandong Provincial Government has greatly enhanced industrial pollution controls in the XRB through policies and actions; has increased the water flow from the Yellow River to the Xiaoqing River; and has constructed 13 wastewater treatment facilities in the basin with a total additional treatment capacity of 750 000 t/d for industrial wastewater. l Institutional strengthening, construction supervision and training (US$3.9 million SAR; US$3.2 million December 2005) Satisfactorily implemented between 1998 and 2005, in two packages: A and B. Further details are given below in paragraph 9. 8. Net present value/economic rate of return Net present value (NPV) and economic rate of return (ERR) for each component were calculated at appraisal and documented in the SAR. However, there are insufficient data to estimate the NPVs and ERRs for the five components at project completion. In addition, assumptions and details for the original calculations at appraisal are unavailable and, therefore, comparisons of this nature, using the same basis, either is not possible or would be largely meaningless. Institutional development impact Institutional capacity building and training has been carried out through five contract packages including: · Package A : institutional and financial strengthening · Package B: construction supervision · Package C: institutional support and equipment for Environmental Protection Bureau · Package D: training and Management Information Systems (MIS) support · Package E: other – equipment and support for provincial and other finance bureaus. The objectives of the above packages have been achieved through extensive work by the consultants and the implementing agencies. The project successfully helped create three new public utility entities: Jinan Municipal Drainage Company, Yantai Heat Supply Company and Weihai Botong Heat and Power Company. Institutional development and training has been provided to these new companies, with the existing Jinan Water Supply Company, the Provincial Project management Office (PPMO), Provincial EPB and finance bureaus all involved in the implementation of the project. Both the new and existing utility companies have benefited from considerable improvement in the prospects of sustainability through institutional development, in particular the work of Package A. This package introduced and implemented, for each company, a computerized financial management system, cost accounting, business planning, human resource development, performance measurement and training system. Package B was primarily involved construction supervision, coupled with procurement and construction management support to the PPMO and the Implementing Agency (IA) and training to local counterpart construction supervision personnel. Packages C, D & E focused on the PPMO, the EPB and finance bureaus, including implementing various training programs, procuring needed equipment and establishing MIS systems etc.

9. Poverty alleviation and social improvement This project has also had important social benefits, despite its objectives being originally focused on environmental improvement. Several hundred new and permanent jobs have been created in the three new public utility companies and many temporary jobs were created during the construction of the

- 46 - facilities. Millions of people are now benefiting from the better air quality and a much improved heating system in Yantai and Weihai and millions are enjoying a safe and reliable water supply in Jinan. The improved water environment in the Xiao-Qing River system will benefit many farmers and families in the area by providing better living conditions. Other benefits occurred in association with the project, including resumption of water flow in the famous Bao-Tu Spring in Jinan, as a result of the recovery in the groundwater level. This spring is visited by millions of tourists and local residents annually.

Major factors affecting implementation and outcome

10. Factors outside the control of government or implementing agencies Immediately after the completion of the heating supply system, slower than expected development of some areas by private investors in Weihai delayed connection to a number of heat-users between1999 to the early 2000’s. However, development has increased dramatically over recent years, resulting in the much higher heat demand which caused Weihai to expand the system using the loan savings. Market price escalation on major construction materials during 2003 and 2004 caused problems for construction progress on some civil works contracts which had been bid on a fixed price basis. 11. Factors generally subject to government control Slow government approval processes on new projects using loan savings have delayed the start of construction. Eventually these new projects were implemented on a retroactive basis for the first year. There have been many complaints from the IAs that it took too long to gain the required approval on ICB goods bidding documents and bid evaluation reports. Government restrictions on breaking road surfaces within city areas at certain times during any year have also had an impact on construction progress for pipeline projects. 12. Factors generally subject to implementing agency control Cost estimate at appraisal was inaccurate. l Actual costs for civil works and goods categories do not match that estimated at appraisal. This affected the progress of disbursement, as adjustment of World Bank financing on goods and civil works categories needs to be approved by the Ministry of Finance (MOF) and will take time. l Costs estimated using government rates at appraisal are generally much higher than actual contract prices, causing large loan savings. But it needs to go through a long and complicated process in order to use the loan savings. There were cases where the IAs tried to implement unreasonably tight construction schedules, thereby causing potential variations/claims by the contractors.

Sustainability

13. Sustainability assessment Sustainability may be assessed in terms of (1) whether the appropriate institutional arrangement has been set up (2) the ability to operate and maintain the facilities (3) the adequacy of sustainable financing capability.

- 47 - The overall project can be considered sustainable against these criteria, although there are issues to be resolved in the future. Yantai Heating Supply Company and Weihai Heat & Power Company, although newly established enterprises, are considered fully sustainable in terms of institutional arrangements, operational capacity and financial strength. Jinan Water Company (JWSC) is sustainable in the institutional and operational context but it is currently running at a loss. This is primarily because sales do not match its full production capacity, as many industries have been using self-supply water sources as these are currently cheaper than JWSC supply. However, the situation is likely to improve with the enforcement of the central government’s directive which requires that self-supply be shut down if a municipal water supply source is available. The sales for water supply are also expected to increase with the rapid development of the local economy. In this context, JWSC is likely to be financially sustainable in the near future. Jinan Municipal Drainage Company (JMDC) benefited from institutional strengthening through the Technical Assistance (TA) package and has built sufficient capacity in technical operation, maintenance, business planning, human resource management and financial management. However, there are issues in relation to the transfer of assets and financial autonomy. Some of the existing sewer networks (constructed prior to the project) continue to be owned and operated by the district governments. Consequently, because the wastewater services are provided by different entities, the wastewater tariff collected is remitted to the Jinan Finance Bureau which returns a portion of it to JMDC as a budgetary allocation. JMDC has been continuously lobbying the government to resolve the assets transfer issue. What is being highlighted is that it takes time to resolve this kind of issue as it involves complicated ownership factors and various interested parties. The problem is likely to be resolved within the broader framework of government-initiated reform in Jinan Municipality. Given the fact that reforms in the public utility sector are increasingly a focus for local governments in many cities in China, full sustainability of JMDC in the medium to long term is confidently assured.

Bank and borrower performance

14. Bank We consider the World Bank’s performance highly satisfactory during both project preparation and implementation stages. The Bank’s staff involved in this project has provided very useful assistance, advice, guidance, training and supervision to the project personnel in Shandong, and the diligence of Bank staff is very much appreciated by Shandong PPMO, the IAs, the EPB and the finance bureaus. Quite a number of Task Managers from the WB have worked on this project, and all of them have made valuable contributions to the successful implementation of the project. Although the change in Task Managers is a little more frequent than we expected, it is understandable and acceptable considering the longer than planned implementation period. 15. Borrower The national, provincial and municipal governments have been very committed to and supportive of this project during its inception, preparation and implementation. Strong efforts have been made by all IAs and the SPPMO to resolve issues encountered at every phase of the project. All IAs performed very well in their project management, with good skills and adequate resources. Although Jinan experienced difficulties in relation to land acquisition and resettlement at one stage during the implementation, the issue was eventually satisfactorily resolved with assistance from the provincial government, which showed great support and flexibility under the difficult circumstances. The assets transfer for JMDC remains an unresolved issue which in turn has led to JMDC’s financial uncertainty,

- 48 - but the government has already demonstrated its willingness to deal with the issue.

Lessons learned

16. Lessons learned from the project The implementation of the Shandong Environment Project has provided a good opportunity for SPPMO, the IAs and all other agencies involved to gain valuable experience in institutional development, financial and environmental management, skills improvement and the physical implementation of projects. Lessons have also been learned in many aspects of project execution. A brief summary of experiences and lessons learned is presented below: l The project has assisted Shandong Province to gain significant experience in the implementation of World Bank financed projects, including project initiation, preparation, appraisal, procurement, project management, contract administration, construction supervision, institutional development, and financial management. l A World Bank financed project can bring in advanced management and institutional benefits through the assistance provided by international consultants. l Thorough analysis should be undertaken during the project preparation stage of any uncertain implementation aspects. Flexibility should subsequently be incorporated during the implementation stage. l Price adjustable contracts should be used to combat market price fluctuation. l Cost estimates at appraisal, using government rates, proved excessive; more realistic cost data should be obtained at appraisal stage.

Construction of some sections of pipes within the city area was significantly delayed owing either to resettlement issues or to government restrictions on road surface-breaking. More detailed engineering investigation should be carried out at appraisal stage for pipeline projects within city areas to avoid pipeline routes running through residential blocks. In areas where such issues are unavoidable, tendering or awarding contracts should be put on hold until the land acquisition or road-breaking problem is fully resolved.

- 49 - IBRD 28428 Rongcheng SEPTEMBER 1997 This map was produced by the Map Design Unit Bank. The of The World boundaries,colors, any and denominations other information shown not do map this on on the part of imply, Bank Group, The World any judgment on the legal territory, any of status or any endorsement such of acceptance or boundaries. Weihai Wendeng Huang Hai Muping Rushan KILOMETERS CHINA PROPOSED INVESTMENTS: STORAGE AND TREATMENT WATER PIPELINE SUPPLY WATER SYSTEM DISTRICT HEATING SYSTEMS WASTEWATER XIAOXING RIVER BASIN (POLLUTION CONTROL SUBLOANS) COUNTY (XIAN) HEADQUARTERS PREFECTURE HEADQUARTERS PROVINCE CAPITAL PORTS AIRPORTS RIVERS CANALS HIGHWAYS NATIONAL RAILROADS COUNTY (XIAN) BOUNDARIES PREFECTURE BOUNDARIES PROVINCE BOUNDARIES

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