Technical Assistance Consultant’s Report

Project Number: 40524-012 June 2011

People’s Republic of China: Energy Efficiency and Emission Reduction Project in Shandong Province (Financed by the Asian Development Bank’s Technical Assistance Special Fund)

Final Report

Prepared by: Allan Zhang

ESD China Limited

Shanghai, People’s Republic of China

For: the Shandong Provincial Government

This consultant’s report does not necessarily reflect the views of ADB or the Government concerned, and ADB and the Government cannot be held liable for its contents. (For project preparatory technical assistance: All the views expressed herein may not be incorporated into the proposed project’s design.

Asian Development Bank TA 7295 - PRC: Energy Efficiency and Emission Reduction Project in Shandong Province Final Report 19 April 2011

Asian Development Bank 20/4/11

Consultant Team Contact:

Allan Zhang, PhD, PEng [email protected] ESD CHINA LIMITED Suite 17C, XiZang Zhong Road Shanghai 200001, CHINA Tel: (86-21) 5308-0914 Fax: (86-21) 5308-0915

Version 2.0

Asian Development Bank TA 7295 - PRC: Energy Efficiency and Emission Reduction Project in Shandong Province

TABLE OF CONTENTS

1. Introduction 1-1 1.1 Background 1-1 1.2 Key Chronological Events 1-1 1.3 Report Organization 1-1

2. Rationale for the Proposed Investment Program 2-1 2.1 Overview of China Energy Situation and ADB/PRC Strategy 2-1 2.2 Challenges and Opportunities in Shandong 2-3

3. Lessons 3-1 3.1 Energy Efficiency Related Experiences in China 3-1 3.2 Lessons Learnt 3-2

4. Project Description 4-1 4.1 Project Overview 4-1 4.2 Impact and Outcome 4-1 4.3 Outputs 4-2 4.4 Description of Initial Subprojects 4-2 4.5 Investment Plan 4-10 4.6 Implementation Arrangements 4-11

5. Modified Financial Intermediation Modality 5-1 5.1 Rationale and Design of the Modified Financial Intermediation Modality 5-1 5.2 The Financial Intermediary 5-4 5.3 Specific Terms of the FIL Modality 5-5 5.4 Financing Plan 5-7

6. Executing Agency Capacity Building for Energy Efficiency Improvement 6-1 6.1 EA Capacity Building Needs 6-1 6.2 Capacity Building Technical Assistance 6-2

7. Investment Program Benefits, Impacts, Assumptions and Risks 7-1 7.1 Environmental Benefits and Impacts 7-1 7.2 Economic Analysis 7-1 7.3 Financial Analysis 7-3 7.4 Social Benefits and Poverty Reduction 7-6 7.5 Risks 7-7

8. Policy Recommendations 8-1 8.1 Recommendations to the Government 8-1 8.2 Recommendations to the ADB 8-1

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LIST OF APPENDICES

APPENDIX A: SENERGY SECTOR ANALYSIS

APPENDIX B: ENERGY SECTION REGULATORY FRAMEWORK

APPENDIX C: EXTERNAL ASSISTANCE AND LESSONS

APPENDIX D: PROJECT DESIGN AND MONITORING FRAMEWORK

APPENDIX E: ESTIMATED ENERGY SAVINGS AND EMISSION REDUCTION FOR INITIAL SUBPROJECTS

APPENDIX F: DESCRIPTION OF THREE INITIAL SUBPROJECTS

APPENDIX G: DETAILED COST ESTIMATES

APPENDIX H: SUBPROJECT SELECTION CRITERIA

APPENDIX I: MODIFIED FIL MODALITY FOR SHANDONG ENERGY EFFICIENCY AND EMISSION REDUCTION PROJECT

APPENDIX J: FINANCIAL MANANGEMENT ASSESSMENT OF THE FINANCIAL INTERMEDIARY

APPENDIX K: REVOLVING EFFECT OF THE $100 MILLION FIL

APPENDIX L: ENVIRONMENTAL ASSESSMENT AND REVIEW FRAMEWORK

APPENDIX M: SUBPROJECT ECONOMIC ANALYSIS

APPENDIX N: SUBPROJECT FINANCIAL ANALYSIS

APPENDIX O: SOCIAL AND POVERTY ANALYSIS

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ABBREVIATIONS

ADB – Asian Development Bank

CBRC – China Banking Regulatory Commission

CDM – clean development mechanism

CER – certified emission reduction

CO2 – carbon dioxide

EIRR – economic internal rate of return

MOU – memorandum of understanding

PMO – project management office

ESCO – energy service company

FFA – framework financing agreement

FSR - feasibility study report

FI – financial intermediary

FIL – financial intermediate loan

FIRR – financial internal rate of return

FNPV – financial net present value

FYP – five-year plan

GDP – gross domestic product

SPG – Shandong provincial government

SFB – Shandong Finance Bureau

SDRC – Shandong Development and Reform Commission

SEITC – Shandong Economic and Information Technology Commission

SEPB – Shandong Environmental Protection Bureau

EIA – environmental impact assessment

LIBOR – London interbank offered rate

EPB – environmental protection bureau

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NDRC – National Development and Reform Commission

NOx – nitrogen oxide

PFR – periodic financing request

PRC – People’s Republic of China

SO2 – sulfur dioxide

TA – technical assistance

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WEIGHTS AND MEASURES

MW (megawatt) – 1,000,000 watts

GW (gigawatt) – 1,000 MW

MJ (megajoule) – 1,000,000 joules

GJ(gigajoule) – 1000 MJ

GWh (gigawatt-hour) – 109 Wh

MWh (megawatt-hour) – 1000 kWh

kWh (kilowatt-hour) – 103 Wh

t (ton) – 1,000 kilogram (kg)

tsce – ton of standard coal equivalent

Mtsce – million tons of standard coal equivalent

t/yr – tons per year

Mt/yr – million tons per year

CURRENCY EQUIVALENTS (as of 15 March 2010)

Currency Unit – Yuan (CNY)

CNY1.00 = $0.147

$1.00 = CNY6.80

The exchange rate of the yuan is determined under a floating exchange rate system. In this report, a rate of $1.00 = CNY6.80, the rate prevailing during loan fact-finding, was used.

NOTE

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

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1. INTRODUCTION

1.1 BACKGROUND

In September 2009, the Asian Development Bank (ADB) commissioned a project preparatory technical assistance (PPTA) team to prepare a project appraisal report for the PRC Energy Efficiency and Emission Reduction Project in Shandong Province (the Project, the Investment Program) (TA No. 7295). The Executing Agency (EA) for this Project is the Shandong Provincial Government (SPG). SPG has established a Project Steering Group comprising senior officials from four SPG departments, including Shandong Energy Conservation Office under Shandong Provincial Economic and Information Technology Commission (SEITC), Shandong Provincial Development and Reform Commission (SDRC), Shandong Provincial Finance Bureau (SFB), and Shandong Provincial Environmental Protection Bureau (SEPB). A Project Management Office (PMO) has been established under the Project Steering Group that will be responsible for overall implementation of the project.

The project team consisted of ADB Task Manager, ADB project officers and individual consultants appointed by ADB. Under the support and guidance of the SPG/PMO and the ADB Task Manager, this report has been prepared by the ADB consultant team, including the following members:

Dr. Allan ZHANG – Energy Efficiency and Emission Reduction Specialist/Team Leader Mr. FEI HaoFeng (Roger) – Energy Efficiency Specialist Mr. ZHU Chao – Environmental Specialist Dr. WEI SongXian – Social and Economic Specialist Ms. YANG Huan – Financial Specialist

1.2 KEY CHRONOLOGICAL EVENTS

The TA inception mission was commenced in Jinan, Shandong on 21 September, 2009. The key chronological events of the PPTA included:

Kick-off Meeting and Site Visits in Shandong September 2009 Inception Workshop in Jinan September 2009 Inception Report November 2009 Mid-term Meeting in Beijing/Jinan January 2010 Draft Final Report April 2010 TA Final Workshop April 2010 Selection of Financial Intermediary May 2010 Approval of Subproject EIA and FSR September 2010 Bank Fact-Finding Mission and Signing of Loan MOU August 2010 Circulation of DRAFT RRP September 2010 Bank Management Review Meeting December 2010 Loan Negotiations March 2011 ADB Board of Directors’ Approval March 2011 Signing of Loan Agreement July 2011

1.3 REPORT ORGANIZATION

The final report is organized in a format similar to that of the Report and Recommendation of the President to the Board of Directors (RRP). The next chapter summarizes the rationale for the proposed Energy Efficiency and Emission Reduction (EE&ER) project in Shandong Province. Chapter 3 provides an overview

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Asian Development Bank 20/4/11 TA 7295 - PRC: Energy Efficiency and Emission Reduction Project in Shandong Province of national and international experiences with other EE&ER projects and highlights the features of this Project in light of the lessons learnt. Chapter 4 provides an overview of the Project and outlines the project implementation arrangements. Chapter 5 provides a description of the design of the revolving financial intermediation loan (FIL) mechanism and expected financial outcomes of the FIL. Chapter 6 summarizes the economic, financial, environmental and social analyses of the proposed initial three subprojects. The needs for institutional capacity building required for successful implementation of the Project are identified in Chapter 7. Finally, policy recommendations accumulated through this PPTA are summarized in Chapter 8 for the future use of SPG and ADB.

There are 16 appendices containing detailed analyses and assessments of the Project, detailed descriptions of the proposed initial subprojects as well as implementation guidelines for subsequent subproject selection.

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2. RATIONALE FOR THE PROPOSED INVESTMENT PROGRAM

2.1 OVERVIEW OF CHINA ENERGY SITUATION AND ADB/PRC STRATEGY

2.1.1 Overview of China Energy Situation

The People’s Republic of China (PRC) has the world’s second largest manufacturing sector and is the world’s largest exporter of goods. It has maintained average annual gross domestic product (GDP) growth in excess of 9% for the past quarter of a 1 century. With an annual increase of carbon dioxide (CO2) emissions of more than 7% in the past 15 years, the PRC is now widely reported to be the second largest greenhouse gas emitter after the United States. 2 However, the PRC, which had highest energy intensity in 1980, has since experienced the strongest improvement in energy productivity3 of about 5% per year on average (7.5% per year from 1990 to 2000). In 2006, the PRC’s energy intensity per unit of GDP was about 20% higher than the Organization for Economic Co-operation and Development (OECD) average4 and 2.37 times that of Japan.5 In 2008, the PRC's energy intensity6 was slightly above the world average, whereas it was 80% higher than that in 1990, and about 40% above the average of Europe.7

Approximately 69% of the PRC's primary energy demand is met by coal, and 83% of the electricity is generated from coal8. The PRC has the third largest proven coal reserves in the world; it is the world’s largest coal producer and consumer. Its coal production accounted for 38% of global production in 2008, and is projected to increase to 49% by 2030. Coal-fired power generation, using conventional power generation technology9, results in serious environmental issues and accounts for about 50% of the nation’s sulfur dioxide (SO2) emissions, 80% of nitrogen oxide (NOx) emissions, and 26% of carbon dioxide (CO2) emissions. Acid rain, caused primarily by SO2 and NOx, falls on one third of the country. Approximately, 48% of the cities fail to meet the national air quality standards.10

1 OECD. 2010, Economic Survey China 2010. Paris: OECD. 2 Ministry of Environmental Protection. 2009. State of Environment Reports. Beijing: Ministry of Environmental Protection. 3 Productivity reflects the nature of the economic activity, structure of the energy mix, climate, and technical energy efficiency (footnote 4). 4 OECD. 2006. Environmental Performance Index, China. Paris: OECD. 5 World Bank. 2006. World Development Indicators 2006. Washington, D.C: World Bank. 6 Energy intensity is a measure of the energy efficiency of a nation's economy. It is calculated as units of energy per unit of gross domestic product. 7 World Energy Council. 2008. Energy Efficiency Policies around the World: Review and Evaluation. London: World Energy Council. 8 Global Environment Facility. 2009. Thermal Power Efficiency Project. Washington, D.C: Global Environment Facility. 9 The most common conventional power generation technology is based on steam turbines with sub critical parameters and pulverized coal-fired boilers. The “critical” parameter is 22.1 megapascals, or about 218 times the standard atmospheric pressure, when water changes directly from liquid to the steam phase with the addition of energy. Modern power plants based on “supercritical” or “ultrasupercritical” parameters have considerably higher transformation efficiency and require less coal input and consequently have lower emissions of pollutants and CO2. 10 World Bank (2007) Cost of Pollution in China, Class II Ambient Air Quality Standards, Conference Edition. Washington, DC.

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2.1.2 Strategies of the Government and the Asian Development Bank

The PRC government recognizes the environmental challenges and climate change impacts of its growing energy use, and is aggressively addressing environmental issues and low energy efficiency in the economy with specific targets in the Eleventh Five Year Plan: (i) SO2 emission reduction of 10%, and (ii) energy efficiency improvements of 20% per unit of GDP. Furthermore, the government has formulated (i) the China Medium- and Long-Term Energy Conservation Plan,11 which has the goal of improving energy efficiency and resource utilization; and (ii) the Decision of the State Council on Enhancing Energy Conservation in 2006 (Guo Fa, No. 28) emphasizing energy conservation. The recently amended Energy Conservation Law became effective on 1 April 2008, and in November 2009 the government announced a plan to reduce carbon intensity of its GDP by 40%–45% by 2020 from the 2005 base level. In 2006, the National Development and Report Commission (NDRC) launched the “1000 Large Industrial Enterprises Energy Conservation Action Plan”, targeting at the top 1,008 largest industrial energy consumers, which account for approximately 30 percent of China’s total primary energy consumption. The Government’s efforts also include policy initiatives to foster technology development and deployment, and various fiscal incentives to improve energy efficiency. Meanwhile, the Government has implemented significant reforms in the energy sector. The key national energy enterprises now have autonomy for investment decisions; coal prices are being gradually deregulated; only some of the coal used for power generation is now administratively priced; the power subsector was unbundled in 2003 with the creation of five national and several jointly owned provincial power generation companies, along with two power transmission and distribution companies that have provincial subsidiaries. The independent State Electricity Regulatory Commission now has its presence in all provinces. The NDRC regulates the retail electricity tariff.

ADB’s operational strategy aims at inclusive economic growth in an efficient, equitable, and sustainable manner. In its long-term strategic framework 2008–2020 12 (Strategy 2020) , ADB has identified energy as a core operational sector and achieving environmental sustainability as a strategic priority. ADB has also introduced new initiatives to augment its assistance to developing member countries for acquiring low-carbon technologies and implementing energy efficiency projects. 13 ADB’s country partnership strategy for the PRC has also emphasized on balanced and sustainable growth with more efficient uses of resources and more stringent protection of the environment. Consequently, ADB priorities and strategies in the energy sector are highly consistent with those of the PRC. In 2007, ADB introduced an innovative mechanism to promote energy efficiency projects packaged as an “Efficiency Power Plant (EPP)” in its Guangdong Energy Efficiency and Environmental Improvement Investment Program. The proposed EE&ER Project in Shandong Province with financing of about $100 million will strengthen this strategic link and support both national and provincial development priorities.

11 National Development and Reform Commission. 2005. China Medium and Long Term Energy Conservation Plan. Beijing. 12 ADB. 2008. Strategy 2020: The Long-Term Strategic Framework of the Asian Development Bank 2008–2020. Manila. 13 ADB. 2008. Country Partnership Strategy (2008–2010): People’s Republic of China. Manila

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2.2 CHALLENGES AND OPPORTUNITIES IN SHANDONG

Shandong is the second largest PRC province in terms of industrial outputs. It comprises 17 municipalities and 139 counties, districts, and cities, spread over 156,700 km2 with a population of 94.17 million (2008). It borders Hebei Province to the north, and faces Bohai Bay and the Yellow Sea to the east. Its total GDP was CNY3.1 trillion in 2008, representing approximately 11% of the nation’s total GDP. Shandong's economy has grown consistently at a rapid rate, expanding at 12.5% per annum for the past 15 years (1995–2009)14, significantly higher than the national average. This economic growth momentum in Shandong is expected to continue in the foreseeable future putting even greater emphasis on accelerating investments in energy efficiency.

2.2.1 Challenges

The primary energy demand in Shandong Province is met predominantly by coal (77% in 2009) and oil (21% in 2009). More than one-third of the total final energy consumption in the province was directly from coal (see Appendix A). As well, some 99% of power generation capacity is from coal-fired power plants.

In 2009, total energy consumption of Shandong Province was 314 million tons of standard coal equivalents (Mtsce) – approximately 10% of the national total of 285,000 Mtsce. As a result of a combination of high energy consumption and heavy reliance on coal consumption, Shandong Province was the largest emitter of sulfur dioxide (SO2) amongst all the provinces, accounting for 7.5% of total SO2 emission in the country in 2008. In addition, it was responsible for an estimated 10% of the national total nitrogen oxide (NOx) emissions and 8% of CO2 emissions. Over one- third of the province experienced acid rain in 2008, primarily as a result of SO2 and NOx pollution. Approximately, 48% of cities in the province fail to meet the national air quality standards. Emission reduction, hence, remains a huge challenge for the province, which cannot be met without substantial improvement of energy efficiency.

Structurally, energy consumption in Shandong Province is dominated by energy- intensive heavy industries, including power generation, petroleum and petrochemical, chemical, construction material (cement), coal, steel and iron, nonferrous metals, mechanical, textiles, and other manufacturing industries. In 2008, secondary industrial consumers accounted for approximately 76.62% of total energy consumption; tertiary industry for approximately 12.68%; and primary industry and nonproduction consumption for the remaining 7.68%. The current industrial structure, as a result of historical development of the province’s economy, is unlikely to change in the foreseeable future. An extensive analysis of Shandong’s energy sector is provided in Appendix A.

Numerous industrial facilities in Shandong Province are old with low energy efficiency. Phasing out outdated production capacities has not been an easy task. For example, according to the unified national plan - in the Eleventh Five-Year Plan (2006-2010) - the province needs to shut down 4.3 gigawatts (GW) of small thermal power plants and eliminate outdated production capacity of 4.9 million tons (Mt) of iron and 7.91 Mt of steel. But the existing requirement for phasing out energy inefficient equipment and technologies relies heavily on administrative measures, which have not been

14 Shandong Statistic Yearbooks (2009 and 2010)

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Asian Development Bank 20/4/11 TA 7295 - PRC: Energy Efficiency and Emission Reduction Project in Shandong Province able to meet the target because of underfunded financial compensation and inadequate regulatory mechanisms (footnote 8).

The potential for energy efficiency investments in Shandong Province is huge, especially in energy-intensive industries. However, at least three key barriers may have impeded the development of the lending market for energy efficiency investments in general, and for medium to large-sized industrial energy efficiency investments in particular: 15

(i) Medium to large-sized energy efficiency and emission reduction projects typically are technically more complex and require longer payback periods than small (and often relatively simple) energy efficiency projects. As well, larger energy conservation projects may tend to cause production interruptions during construction and/or installation;

(ii) The PRC commercial banks are asset-based lenders; lack of additional revenue generation by energy efficiency projects creates difficulties for banks to assess cash-flow benefits and forgo collateral for significant lending; and

(iii) The risk perception among the domestic commercial banks has been compounded by their relative unfamiliarity with industrial energy conservation practices, as well as the market and technical complexity associated with some energy efficiency projects. The significant initial cost involved in developing the internal capacity for proper appraisal has resulted in a general lack of institutional focus by domestic commercial banks on energy efficiency projects.

Furthermore, in the currently underdeveloped energy service company (ESCO) market in the PRC, most ESCOs are small- to medium-sized enterprises with limited equity and collateral capacity, let alone technical and financing sophistication, to invest in medium- to large-sized EE&ER projects in midstream industries. The added complexity stems from difficulty in measuring and verifying energy savings from complex industrial processes.

2.2.2 Opportunities

The high concentration of energy-intensive heavy industries and relatively low energy efficiency require Shandong Province to reduce its energy intensity by 22% and SO2 emissions by 20% (from 2.0 Mt to 1.6 Mt) within the 11th FYP 2006 to 2010—more aggressive targets than the national averages.

To meet these targets, the provincial party committee, together with the provincial government introduced Proposals on Further Strengthening the Work of Energy Saving and Emission Reduction (2007). The provincial government formulated The

15 The size of an energy efficiency investment is defined by the estimated investment cost of a single energy efficiency technology intervention. The targeted energy efficiency investments of the proposed project range from $10 million and above, compared with small investments in the range of $1 million to $5 million or less. The size of an industrial enterprise is defined by its annual revenues. According to the China State Statistical Bureau (2008 Guidelines), enterprises are defined as medium-sized if their annual revenues are in the range of CNY30 million to CNY300 million (approximately $4.4 million to $40 million), and large if in excess of CNY300 million.

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Comprehensive Plan of Implementation of Energy Saving and Emission Reduction in Shandong Province; implemented Plans and Methods for Energy Saving and Emission Statistics, Monitoring and Assessing; introduced energy-saving incentives and a price escalating system for excessive power consumption; and established organization and policy systems for guiding and promoting energy-saving work. In the first 3 years of the Eleventh Five-Year Plan (2006 – 2010), Shandong Province's energy consumption per CNY10,000 GDP declined by 13.8% compared to the target of 22%. By 2009, its energy intensity improved to 1.072 tsce per CNY10,000 of GDP16, representing a cumulative reduction of 18.5%.

Despite the improving energy intensity, the province ranked at 19th amongst the 30 provinces in China in 2009. The underinvestment in energy efficiency and the existence of many energy-intensive industries in the province provide significant opportunities for further energy intensity reductions through targeted investment. The revised Energy Conservation Ordinance of Shandong Province took effect from November, 2009, which established a policy framework for energy efficiency improvement and pollutant reduction in Shandong, as outlined below:

 SPG will continue to enforce its policy to close serious, continuous polluters, allowing more energy efficient firms to develop and inefficient firms to fall. Further, the SPG’s economic strategy will focus on supporting those industries in moving up the value chain in order to help diversify the economy into high value-added, likely less polluting, sectors. One such effort is to retire small (typically less efficient with higher SO2 emission) thermal powers plants and incorporate a market-based SO2 cap-and-trade mechanism (footnote 8);

 Energy users shall abide by the state standards on energy conservation and the quota of energy consumption of both unit production value and unit product output set by the provincial energy conservation office and or SDRC. Key energy users shall regularly submit reports to corresponding statistics departments and energy conservation agencies on the status of energy utilization in accordance with the relevant state regulations;

 Energy efficiency of energy-using equipments like kilns, boilers, transformers, compressors, fans and pumps are required to meet the relevant national and provincial energy conservation standards. Energy users shall be required to upgrade or phase out the energy-using equipments that do not meet the relevant standards within certain deadlines;

 SPG shall encourage local financial institutions to support energy efficiency improvement and pollutant reduction projects;

 SPG will allocate energy conservation funds from both capital construction and technological restructuring investment funds to support rational energy utilization and development of renewable sources of energy;

 SPG shall encourage and support enterprises, science and research institutes to develop and popularize new energy saving technologies, techniques, materials and equipments. New products, which are included in the plans of the State and the province, will enjoy preferential policies. The provincial

16 Source: Shandong Network, http://www.sdgb.cn/270675.aspx

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government would encourage and support enterprises to adopt application of hi-technology in comprehensive energy utilization; and

 Promote public awareness through enhanced dissemination of information, knowledge and education on energy conservation.

A reference index of Shandong provincial energy policies and incentive programs is provided in Appendix B. These regulatory pressures, policies and incentive programs will help create favorable investment environment and numerous project opportunities for the EE&ER sector in Shandong.

The consensus among Chinese experts is that most of the existing fixed assets in Shandong’s energy intensive industries, especially those in medium- and large-sized enterprises, will still remain in production until at least 2020. Hence, the majority of the energy saving potential would be attributable to retrofitting of energy intensive facilities at existing industrial and commercial establishments. There is thus a window of opportunity in the next five years to rehabilitate and upgrade these existing industrial assets to substantially improve their energy efficiency.

However, the significant potential for energy efficiency improvement and green house gas (GHG) emission reduction is largely untapped in Shandong as most of the concerned enterprises would rather invest in business expansion than in energy conservation projects, although the Chinese experts agree that the majority of the identified industrial energy conservation investments are of high investment returns. The domestic banking sector has also been reluctant to step in to provide the required financing for the reason discussed in the previous section.

Despite SPG’s efforts in the recent years, there remains significant potential for energy efficiency improvement and green house gas (GHG) emission reduction as most of the concerned enterprises would rather invest in business expansion than energy conservation, although the Chinese experts agree that the majority of the identified industrial energy conservation investments are of high investment returns. The domestic banking sector has also been reluctant to step in to provide the required financing for the reason discussed in the previous section.

Part of the solution to the lack of investment desire in energy efficiency is to encourage the growth of ESCOs by private investors, manufacturers/distributors of energy efficiency equipments and/or vendors of energy efficiency technologies. ESCOs typically assist consumers by sharing the benefit of energy saving through energy performance contracts (EPC), wherein they finance the installation of energy efficiency equipments, implement energy efficient technologies and recover the investments from the savings in consumers’ electricity and fuel bills. This model has been adopted internationally; however, it runs into a number of persistent barriers in China, including low capitalization of ESCOs and lack of access to debt from domestic banks. The Government has long recognized the key role of ESCOs in meeting the energy efficiency and emission reduction project financing demands. Most recently, the State Council issued a circular outlining the national incentive programs, including provisions for ESCOs to access the central government budget currently designated to energy saving rewards and subsidies, a variety of pro-ESCO tax breaks and preferred accounting rules, encouragement to banks and other

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Asian Development Bank 20/4/11 TA 7295 - PRC: Energy Efficiency and Emission Reduction Project in Shandong Province financial institutes to provide innovative financial instruments and to simplify loan applications and collateral requirements for ESCOs. 17

The small but developing ESCO industry in Shandong can expand into a full energy service industry with lowered barriers; and that has been identified by the SPG as a policy priority. Shandong was one of the three pilot provinces to set up one of the earliest ESCOs in the PRC in as early as 1998, called Shandong Rongshihua Leasing Co. (Rongshihua), with assistance from the World Bank - Global Environment Facility (GEF) (1998-2018). However, ESCO development in Shandong so far has primarily benefited small energy efficiency projects with an average investment of less than $1 million each,18 involving relatively simple technologies, such as upgrades of small boilers, pump and motor drives, lighting, air conditioners, and/or transformers. The potential ESCO financing opportunities for medium- to large-sized industrial energy efficiency and emission reduction projects remain largely untapped and hence warrant policy intervention.

17 Circular of the State Council, Development Reform Commission and other departments to speed up implementation of energy management contracts for the development of the energy service industry (Office of the State Council [2010, No. 25]). 18 A total of 86 projects with an average size of approximately $850,000 are set up under the World Bank financing program. (Source: a report to Shandong ADB PMO by Rongshihua).

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3. LESSONS

3.1 ENERGY EFFICIENCY RELATED EXPERIENCES IN CHINA

China is making impressive efforts to improve energy efficiency in every sector of its economy. For example, with the assistance of numerous international development organizations, China is developing a wide range of programs, regulations and incentives designed to transform the market for energy efficient technologies. These activities include the creation of efficiency codes and standards, product certification and labeling programs, development of private ESCOs, demonstration projects, training courses, and public education programs.

In recent years, several energy efficiency programs have been implemented. China Green Lights was launched nationwide in1996. Pilot Demand Side Management (DSM) programs aimed at energy efficiency were launched in Hebei and Jiangsu; programs encouraging the use of variable-speed drives (VSD) in industrial applications were launched in Jiangsu and Shanghai. In 2003, Hebei became the first province to implement a surcharge of CNY 0.001 Yuan/kWh on retail electricity sales specifically to fund investment in DSM.

One of the current priorities for energy efficiency is China’s Top-1000 Enterprises Energy Efficiency Program (T-1000). This program is targeted at China’s 1008 most energy-intensive enterprises, drawn from nine major energy consuming industries including iron and steel, non-ferrous metals, coal, electric power generation, petroleum and petrochemical, chemicals, building materials, textiles and paper. The energy consumption of the T-1000 enterprises accounts for 33 percent of the nation’s total energy consumption. Elements of the T-1000 program include the setting of energy saving targets, energy auditing, energy planning, and tracking and evaluation. The plan is designed to reduce unit energy consumption to domestic best-practice levels for all major products; drive some enterprises’ energy use to either international best-practice levels or sector best-practice levels in the country; improve the energy efficiency of the targeted sectors; and achieve energy savings of approximately 100 Mtsce during the 11th FYP period. The target has been broken down to the factory level and a total of 1,008 enterprises have reached their energy savings target in the past five years.

In 2008, the ADB Guangdong Energy Efficiency and Environment Improvement Investment Program was implemented, which successfully introduced the on-lending mechanism to finance energy efficiency retrofits in Guangdong Province. The Investment Program considered only retrofits of proven energy efficiency technologies in the following areas: (i) motors and motor-drive systems; (ii) transformers and reactive power compensators; (iii) lighting; (iv) heating, ventilation and air conditioning (HVAC); (v) air compressors and pumping systems; (vi) recovery of waste energy from industry; (vii) industrial boilers and industrial cogeneration; and (viii) other related energy efficiency improvement projects. The energy savings for the Project resulted from retrofitting existing equipment with more efficient equipment, which in aggregate reduced the need to construct and operate an equivalent coal- fired conventional power plant, so it was called the efficiency power plant (EPP) and was the first of its kind in the PRC. This Project would be an improvement in energy efficiency in industry and commercial sectors in China. The expected outputs included: (i) establishment of an on lending model that will enable an EPP to be developed with annual 532 GWh energy savings and an equivalent of 107 MW power generation capacity, (ii) development of the energy service sector in Guangdong, (iii)

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3.2 LESSONS LEARNT

ADB’s experience in the PRC’s energy sector indicates that projects are generally well planned and implemented smoothly. The overall implementation performance of ADB’s energy portfolio is satisfactory (see Appendix C). Several lessons may be derived from the previous financial intermediation loans (FILs) and project loans relate to innovative financing of energy projects. As discussed below, the design of this Project has incorporated a number of lessons learnt from the previous energy projects.

International financial institutes (IFI), such as the ADB and the World Bank/GEF European Investment Bank (EIB) have been very active in Shandong in the recent years with remarkable achievements in the areas of agricultural, infrastructural and environmental developments as well as renewable energy, energy efficiency and emission reduction. However, the relative abundance of domestic capital in the recent years has helped lowered the desire for IFI financing. In comparison with domestic loans, the IFI loan appraisal process has been perceived to be burdened with multiple layers of management oversight, which tend to increase the turnaround time of loan appraisal. The issue may not be as critical for the IFI financing in conventional infrastructural and environmental projects in the public sector but it appears to amplify when appraising energy efficiency projects that involve industries and private enterprises as they are constantly under the high demand of the fast evolving market. The design of this proposed revolving FIL, once set up, is intended to streamline the subproject appraisal and loan management.

Historically, IFI loans in China have been primarily directed towards public sector and state-owned enterprises. This may be, in part, attributable to the state guaranty required for the conventional IFI loans. However, an unexpected “side effect” of the government’s guaranty on IFI loans is that the enterprises may become less active in repayment, increasing the risk on loan repayment. All three initial subprojects under this Shandong FIL are private-owned enterprises, which are guaranteed by the motivated governments: by focusing the initial subprojects on mid-stream industries with key roles in the local industrial value chain, the local governments have been motivated to arrange for the necessary guaranties required for the subloans.

ESCOs can be developed to capture the small-scale segment of the energy efficiency market, typically overlooked by financial institutions. The World Bank and ADB have been actively supporting and financing ESCO pilot projects in China, including the Ronshihua ESCO pilot project in Shandong, funded by the World Bank/GE. However, ESCO is not necessary a versatile solution to a wide spectrum of often complex industrial EE&ER opportunities as it requires a number of inherent attributes for the candidate projects to succeed. For example, the three-country studies - Brazil, PRC, and India - by the World Bank and United Nations Environment Programme, have identified that, among other things, an essential attribute of the candidate projects to be considered for ESCO is that the energy saving amount has to be easy to measure and verify. With the exception of some select niches, industrial EE&ER projects in general can be complex; and it may be difficult to establish a proper baseline for an EE&ER project component inside a large industrial complex and often subject to deputes. One of the initial subprojects in this FIL program is a technology/equipment oriented ESCO specializing in coal washing, which is primarily paid based on the simple tonnage of raw coal processed.

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Other approaches for reducing energy demand are being designed. In addition to the Guangdong EPP and Shandong EE&ER Project, the Energy Efficiency Multi-Project Financing Program prepared by ADB’s Private Sector Operations Department in 2007 has a guarantee mechanism for domestic banks when a preselected ESCO provides the technical services for improving energy efficiency in buildings. The World Bank is preparing a normal FIL, which includes capacity building input from the Global Environment Facility; and another private sector proposal extends guarantees for loans offered by partner domestic banks to utility companies to help consumers improve their efficiency of gas and district heat use. Considering the extremely large potential for improving energy efficiency in the PRC, pilot implementation of various approaches is justified.

More detailed discussions on external assistance and lessons learnt are provided in Appendix C. The proposed project will incorporate lessons from earlier projects regarding design, preparation, risk assessment and management, and implementation arrangements.

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4. PROJECT DESCRIPTION

4.1 PROJECT OVERVIEW

The Project focuses on financing EE&ER subprojects, developing ESCOs, enhancing institutional capacities for identifying and managing EE&ER projects, controlling industrial pollution, and overall environmental management in Shandong province of the PRC.

The Project is to provide a financial intermediation loan for up to $100 million to Shandong province under the ADB FIL modality, scale up investments in EE&ER through revolving uses of funds, mobilize domestic knowledge and financial resources for co-financing and replication, reduce transaction complexities and costs, and strengthen impact monitoring and evaluation.

The initial three subprojects selected in the first batch financing include three private enterprises. The owners of the three subjects are amongst the industrial leaders in their respective industrial subsectors in the country. As discussed further below, of these 3 subprojects, two are for EE&ER at the sponsors' facilities, concentrating on retrofitting existing equipment for higher efficiency, capturing and utilizing fugitive methane and exhaust flue gases, recovering surplus process heat, and using solar power for preheating and steam production. The other subproject is an ESCO division sponsored by a coal mining equipment manufacturer and technology vendor, which will use its own advanced clean technologies and management expertise to assist other enterprises located nationwide to implement EE&ER subprojects, mainly on coal washing for resource conservation and desulfurization.

The design and monitoring framework for the proposed investment program is presented in Appendix D.

4.2 IMPACT AND OUTCOME

The impact of the Project will be improved energy conservation and contribution to the reduction of GHG emission and other air pollutants emission in Shandong and nationally. As discussed below, all three initial subprojects are highly technology- oriented with significant EE&ER outcomes and contain/supplement large scale applications of the state-of-the-art energy efficiency/renewable energy technologies. The successful implementation of the initial subprojects will substantially accelerate energy efficiency and emission reduction in Shandong province and transform the technological applications in their respective industrial sub-sectors in the country. Further, as the initial subproject sponsors are all private enterprises, the successful implementation of the FIL will have a demonstrative effect in how the Chinese government and IFI can work together to effectively promote private (as versus state- owned) industries in China.

The direct outcome of the Project will be enhanced energy efficiency and reduced emissions of GHG and other air pollutants from Shandong's industrial sectors. Performance targets will be set and measured in terms of reduction of the energy intensity, and the total amount of energy savings and reduction of CO2, SO2, and particulate matters (PM) emissions.

As discussed in detail in Appendix E, implementation of the initial three subprojects alone is expected to achieve annual energy saving of around 920,000 tsce, and annual emission reduction of approximately 2,684,000 tons CO2, 22,100 tons SO2,

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7,400 tons NOx, 2,700 tons CO and 1,800 tons PM, starting 2013. A summary of energy savings and emission reductions estimated for the three initial subprojects is provided in Table 1.

Table1: Summary of Energy Conservation and Emission Reduction Estimates for the Three Initial Subprojects in the first batch Item Golden Yimeng SMM Lufang Total Energy Saving 95,448 761,823 62,426 919,697 (tsce/yr)

CO2 (ton/year) 663,054 1,861,426 159,241 2,683,721

SO2 (ton/year) 341 21,102 645 22,088

PM10 (ton/year) 190 1,505 124 1819

NOx (ton/year) 771 6,116 504 7,392 CO (ton/year) 277 2,194 181 2,652 1 ton of standard coal equivalent = 29.31 giga joules (GJ); 1 ton oil equivalent = 41.868 GJ (per International Energy Association and OECD definition), 1 ton oil equivalent = 1.428 ton of standard coal equivalent; PM = Particulate Matter Sources: Subproject feasibility study reports and Asian Development Bank estimates.

Future subproject batches of the Project will consider only those subprojects that can quantitatively demonstrate their impacts on reducing energy intensity, conserving energy resources, and abating emissions of GHG and other pollutants, primarily SO2, NOx and/or PM, using proven EE&ER technologies. Post-installation verification and monitoring will be carried out by a third party to verify that the energy savings and emission reduction are achieved.

4.3 OUTPUTS

The outputs of the Project would include (i) establishment of an onlending model that will help development of priority EE&ER projects implemented in key energy- intensive industries, (ii) ESCO business opportunities enhanced in Shandong Province, and (iii) capacity developed for government and financial institutions on planning and management of energy efficiency investments.

With the revolving financing mechanism, the total investment to be extended within 15 years (2010-2025) is expected to be up to $616 million, including approximately $307.5 million under this ADB FIL. It is anticipated that over 20 EE&ER subprojects would be financed and carried out by 2025; ffinancial support will be provided to at least two ESCOs.

4.4 DESCRIPTION OF INITIAL SUBPROJECTS

From more than 40 candidate subprojects, three representative ones with significant EE&ER outcomes have been selected and evaluated for the first financing batch. All three initial subprojects contain/supplement large scale applications of the state-of- the-art energy efficiency/renewable energy technologies and their demonstrative effects would not be limited to the subsequent subprojects under this FIL or in Shandong.

These initial three subprojects are introduced below. Detailed descriptions of the three initial subprojects are provided in Appendix F.

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4.4.1 Biogas Power Generation, Waste Heat Recovery and Solar Thermal Utilization Subproject by Golden Yimeng Group, Inc.

Golden Yimeng Group Inc. (Golden Yimeng) is based in Linshu County, Linyi municipality of Shandong. Golden Yimeng was previously the Linshu County Chemical Plant established in 1975. It was later transformed into a private shareholding company with main shareholders being Mr. Zhang LiSheng and his family. Golden Yimeng ranks 143rd amongst the top 500 industrial enterprises and 3rd amongst top 50 specialty chemical manufacturers in China. Its main products includes fertilizers (ammonia production and organic fertilizers), acetate esters and carboxylic acid aldehydes, and fermentation alcohols. It is ranked as the number one producer of acetate esters with a market share of 20% in China. It is also a leading producer of industrial fermentation alcohols in China ranking at top 6 while top 1 in Cassava root fermentation in China. It operates a Cassava root production base in Thailand and imports Cassava root from the Southeast Asia as fermentation raw materials. Its production hence generates biomass as by-products for organic or composite fertilizers. Its overall fertilizer production capacity is approximately 1 million tons per year and acetate esters/carboxylic aldehydes production capacity some 800,000 tons per year.

The main engineering components proposed under the Golden Yimeng subproject include:

 Expansion of biogas capturing system for power generation and heat supply;  Utilization of biowaste as fuel and for production of organic fertilizers;  Waste heat recovery and solar thermal utilization;  Energy conservation in organic aldehydes systems; and  Energy conservation in acetate esters production systems.

The Golden Yimeng subproject will expand the biogas capturing system associated with the organic wastewater anaerobic digestion system to approximately 12,000 Nm3/h from the current 3,000 Nm3/h. The captured methane will be used to fuel two biogas boilers that are modified from the existing coal-fired boilers, to generate 39,744 MWh electricity per year through a mid-pressure steam turbine of 6,000 kW. The exhausted low-pressure stream of 1,500,000 GJ heat value per annum will be sent to the industrial end users within the industrial park and domestic users in the adjacent communities.

The fuel gas from the methane gas boilers will be used to dry the biowaste from the wastewater treatment system which has high moisture contents. The dried sludge of over 40,000 t/yr (dry weight) will then be used as boiler fuel, co-firing with coal used by the existing coal-fired boilers, which can replace coal consumption by 12,757 tsce/yr. Meanwhile the biowaste from the alcohol distillation system of approximately 50,000 t/yr (dry weight) will be used to produce organic fertilizers.

An integrated waste heat recovery and solar thermal system will recover the heat from warm wastewater to preheat the boiler feed water (approximately 220 t/h) from approximately 40oC to 80oC; and then the solar parabolic concentrators will raise the temperature further to 140oC to feed the coal-fired boilers and to 104oC to feed the biogas boilers. This component will result in a saving of coal fuel by 12,656 tsce/yr.

Upgrades of organic aldehyde production systems include (i) retrofits of evaporation pans, heater exchangers and adsorption towers (with better heat transfer efficiency) and air blowers (with VFD motors); (ii) condensate recovery for softened water; (iii)

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Asian Development Bank 20/4/11 TA 7295 - PRC: Energy Efficiency and Emission Reduction Project in Shandong Province heat recovery from process liquid/wastewater recirculation and (iv) upgrade of oxidation furnace and associated offgas treatment system with better combustion and heat exchange efficiency. The proposed upgrades on the organic aldehydes production systems will result in savings of electricity by 1,666 MW/yr, mid-pressure saturated steam by 30,000 tons/yr, low pressure superheat steam by 37,000 tons/yr, softened water by 36,060 m3/yr and other energy savings equivalent to 7,050 tsce/yr.

The upgrade of the acetate ester system includes primarily upgrades of esterification column and dehydration tower, which will result in a saving of low pressure superhot steam by approximately 200,000 t/yr.

Overall, with the implementation of the above project components, the annual energy saving is expected to reach approximately 95,500 tsce; annual emission reduction of CO2 is expected to be approximately 663,000 tons, SO2 340 tons, PM 190 tons, and anaerobic sludge 271,800 tons. A breakdown of the above energy saving and emission reduction figures is provided in Table 2.

According to the 2007 energy audit report by others, Golden Yimeng’s total and sole fuel consumption in 2006 was 233,994 tsce. The projected annual energy saving resulted from the above proposed subproject components would be equivalent to 40% of the total fuel consumption in 2006. A detailed description of the Golden Yimeng subproject is provided in Appendix F, including the schematics of proposed processes.

Table 2: EE&ER Estimates of Golden Yimeng Subproject Components

Emission Total Net Energy Saving Reduction Engineering Energy per CNY 10,000 Project Components Costs Saving Cost CO2 SO2 (million CNY) (tsce/yr) (tsce/yr) (t /yr) (t /yr) Biogas power generation & heat supply 132.20 43,450 32,900 530,460 155 Heat recovery & solar thermal system 75.26 12,656 16,900 32,273 45.4 Sludge utilization 32.11 6,576 20,500 16,769 23.5 Upgrade of organic aldehyde systems 57.04 12,776 22,400 32,565 45.6 Update of acetate ester system 43.20 19,990 46,300 50,987 71.4 Total 339.81 95,448 28,100 663,054 341 Source: Feasibility study report and ADB estimates.

4.4.2 Flue Gas Heat Recovery and Emission Reduction Subproject by Dongying Lufang Metallic Materials Co. Ltd.

The subproject sponsor, Dongying Lufang Metallic Materials Co. Ltd. (Lufang), is a wholly-owned subsidiary of Dongying FangYuan Non-Ferrous Metals Co. Ltd. Established in 1998, Dongying FangYuan Non-Ferrous Metals Co. Ltd. (FangYuan) is reportedly the number one private–owned industrial enterprise in China, with a total revenue of over CNY12.0 billion in 2008. FangYuan’s core business is in manufacturing, recycling and sales of non-ferrous metals, including gold, silver,

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The proposed flue gas heat recovery and desulfurization project supplements a multi- metal ore smelting system of Lufang, which has a designed ore processing capacity of 1 million t/yr and nominal blister copper production capacity of 150,000 t/yr. The ore smelting furnace uses the proprietary Oxygen Bottom Blown Smelting technology developed by China Enfei Engineering Technology Co., Ltd. (Enfei). Enfi’s first industrial scale trial of the Oxygen Bottom-Blown Smelting technology in copper production was at the Tai Lung copper smelter plant in Vietnam, with a nominal processing capacity of 10,000 t/yr. Lufang smelter was the first full scale application of the Oxygen Bottom Blown Smelting technology in copper production. More importantly, through its Phase I process optimization, the smelting/reaction furnace of 50,000 t/yr design capacity has now become a virtual “Zero Coal” process. Unlike other conventional blister copper smelting technologies which require a mix 3% - 6% coal or coke to the ores in the feedstock as fuel, the Enfei “Zero Coal” technology requires virtually no coal/coke mix with the ores in the feed stock, with the exception of the fire-up period. The phase II Oxygen Bottom Blown Smelting Furnace (OBBF) is the first “Zero Coal” blister copper smelting furnace by design in the world. Without the need for coal/coke addition as fuel, the “Zero Coal” technology reduces direct CO2 emission by 110 to 220 kg CO2/t ore or 800 kg/t blister copper. As well, the elimination of coal addition will further reduce the oxygen demand which would consume electricity to generate, resulting in indirect reduction of CO2 and SO2 emissions.

This major breakthrough in the copper smelting technology has been identified by the State Council in 2009 as a national backbone technology, which will set the new market entry standard for future copper smelters with profound impact on the EE&ER efforts in the copper manufacturing industry in China.

The proposed flue gas heat recovery and emission reduction subproject consists of the following components:

 Waste heat recovery by three high temperature heat recovery steam boilers (HRSBs), including one boiler of 28.75 t/h capacity following the OBBF and three boilers of 12.1 t/h - 13.0 t/h capacity each following each of the three Converting Furnaces (CFs). The high temperature HRSBs will cool high temperature flue gas from 750oC-850oC to approximately 350oC to produce mid-pressure steam (4.0 mPa, steam T250oC) for power generation. The generated mid-pressure steam totaled at 52.95 t/h - 54.75 t/h is to drive a steam turbine power generation station to generate 4640 kW - 5680 kW electricity (10 kV/50Hz);

 Waste heat recovery by four mid temperature HRSBs, including two boilers of 5.0 t/h each capacity (steam pressure 0.8 mPa, T170oC) following the two sets of settlement furnaces and anode furnaces (AFs), respectively, and two other boilers of 12.4 t/h capacity and 14.4 t/h capacity (steam pressure 0.6 MPa, T159oC) associated with the stage 3 and stage 4 sulfuric acid reaction processes. The mid temperature HRSBs will cool mid temperature flue gas

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from 650oC-750oC to approximately 180oC to 250oC to produce low-pressure steam for process use and winter heating;

 Flue gas from OBBF and CFs will then be treated by electrostatic precipitators (ESP) for dust removal, which is followed by a sudden temperature drop o o process, from some 350 C to 120 C, to recover As2O3 in particulates as a by- product for cost recovery;

 The treated flue gas from OBBFs and CFs containing SO2 concentration of approximately12% (v/v) will be subject to a 4-stage sulfuric reaction process to convert SO2 to sulfuric acid as a by-product for cost recovery, resulting in 887941 t/yr of 98% industrial sulfuric acid;and

 The offgas from the sulfuric acid production process, containing SO2 up to 775 mg/m3, will be combined with the AF flue gas as well as smokes from other sources of the smelter plant, and be treated for desulfurization by a semi-dry limestone moving bed technology. The combined flue gas of 687405 Nm3/h 3 containing a SO2 concentration of 700 mg/m will be treated to remove 90% SO2, resulting in the final SO2 emission concentration of ≤100 mg/m3 (or ≤68.73 kg/h) to be emitted to the air via a 70 m high stack.

With the implementation of the above waste heat recovery and emission reduction processes, the total energy savings are expected to reach approximately 62,400 tsce/yr. As indicated in Table 3, this would represent a recovery of over 45% of the overall energy inputs to the smelting plant. In addition, the electric power and steam generated through the waste heat recovery can also avoid CO2 emission reduction by approximately 159,200 t/yr and SO2 emission by 318 t, which would otherwise be caused by the coal fired power plant that generates the power. The above have not accounted for the CO2 emission reduction resulted from the “Zero Coal” technology applied in the main production process.

Further, with the SO2 removal processes, the SO2 emission can be reduced to 68.73 kg/h (544 t/yr in 330 production days per year), which is much lower than the applicable GB16297-1996 Class II Emission Limit of 960 mg/m3 and 110 kg /h (871 t/yr), representing a net emission reduction over the regulatory compliance limit by 327 t/yr. Therefore the total calculated SO2 emission reduction of this subproject would be 646 t/yr.

A detailed description of the Lufang subproject is provided in Appendix F, including schematics of the proposed processes.

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Table 3: Summary of Waste Heat Recovery at Lufang OBBF Smelter

Energy Inputs of the 1 million t/yr OBBF Multi-Metal Ore Smelter Total Energy Standard Consumption Coal Total Actual in Standard Energy Conversion Consumption Coal Items Types Factor Units （t/yr） （tsce/yr） % Energy Inputs 1 Coal 0.803 t ce/t 2025 1626 1.2 2 Diesel 1.4446 t ce/t 2000 2889 2.1 3 Tar 1.3648 t ce/t 7485 10,216 7.5 Graphite 4 Electrodes 0.9711 t ce/t 700 680 0.5 Solid 5 Reductant 0.7143 t ce/t 2048 1463 1.1 Total power 6 consumption 0.35 kg ce/kW.h 341120 119,392 87.6 Total 136,265 100.0 Waste Heat Recovery Low-pressure steam 0.1286 tsce/t 239263 30,769 49.3 Power generation Waste mid-pressure heat steam (in power MWh) 0.350 tsce/MWh 48980 17,143 27.5 generation Residual low pressure steam 0.1286 tsce/t 112860 14,514 23.2 Total 62,426 100.0 Overall Energy Recovery（%） (Recovered energy in tsce/Total energy input in tsce) 45.8 Source: Feasibility study report and ADB estimates.

4.4.3 Coal Washing Service Subproject by Shandong Mining Machinery Group Inc.

Shandong Mining Machinery Group Inc. (SMM) was previously a state-owned enterprise established in 1955. It was transformed into a private limited liability company in 1999). SMM is a leading coal mining equipment/system manufacturer in China and is among the top 100 companies in the Chinese coal industry. Its R&D center in Shandong is a provincial level technical center and it also operates an R&D center in Beijing, which specializes in coal washing technologies.

The proposed subproject by SMM is an ESCO division within SMM, which provides coal washing equipment system, technology and operation services to coal mines through a variation of lease-to-own and/or operation services schemes. SMM has more than 40 years history in the coal mining machinery industry, with thousands of clients. There are more than 80 clients who have used the complete set of coal washing equipment systems from SMM. SMM has good understanding of the

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Asian Development Bank 20/4/11 TA 7295 - PRC: Energy Efficiency and Emission Reduction Project in Shandong Province demand of its clients and has sufficient experience and ability to operate with some of its low risk clients under an ESCO approach.

Coal washing is a highly effective energy saving measure from the source (i.e. at coal mines). Coal washing reduces the transportation cost and energy that would otherwise be consumed by waste coal, reduce SO2 emission by removing inorganic sulfur content associated with the raw coal, and improve the combustion efficiency of the end users due to the use of clean coal. As an effective energy saving and emission reduction process, NDRC set the target in 2007 to increase raw coal washing rate from 32% in 2005 to 50% by the end of 11th FYP (i.e. 2010). There is therefore a huge demand in coal washing capacity in the market. Moreover, as discussed above, using SMM proprietary technology, the recovered coal fine alone will pay off the installation cost of coal washing equipments in 10 years.

Despite the apparent benefit and high market demand, there are difficulties for coal mining companies to develop coal washing projects. First, the equipments and technologies of coal washings are relatively complicated (specially the fine coal flotation system). The maturity and reliability of equipments from different manufactures can differ greatly. Medium and small sized coal mining facilities may be lack of competent personnel with adequate knowledge and capability to operate and manage the system. Further, although the coal washing projects can have very good return on investment (ROI), it’s ROI is much low that that of coal mining in the current market. In the past years, as small-to-medium coal mines are being shut down because tightened safety requirements, the market demand for coal outpaces the supply capacity of the remaining mid-to-large size coal mines. As a result, the coal price has been increasing steadily in China and the return on coal mining investment can be as high as 50% in the current market, which makes the ROI of for coal washing facilities of 20% - 30% relatively unattractive.

However, in comparison with other manufacturing sectors, a 20%-30% investment return is still a lucrative business. The current market conditions hence open the door for coal washing equipment suppliers to expand into the coal washing market if provided with right financial and technical strategy.

SMM proposes an innovative ESCO business model to participate in targeted coal washing projects with a combination of technical and financial drives. The proposed ESCO model is designed to tap into the lucrative coal washing business by offering a combination of lease-to-own financing and operational serves (LTOO) to overcome the financial and technical barriers identified above. Under the LTOO model, a complete coal washing equipment system will be supplied with financial support and performance guarantee while the offer for operation outsourcing would address coal mine owners’ concern over lack of operation and management personnel. Once the equipment system has proven its reliability, quality and efficiency through a pre- determined period of operation (typically 3-5 years), the ownership of the equipment can then be transferred to the coal mine company. Through the duration of operation, a local operation team will take shape to allow for a smooth handover of the system to the coal mine owner.

SMM will not be responsible for the infrastructure of the candidate coal washing plants and limits its roles to equipment supply, installation and operation services. As such, SMM’s project selection under this ESCO would be limited to only those projects of which the coal mine owners have secured financing for the civil works/infrastructures and have completed proper environmental impact assessment (EIA) and acquired proper EIA approval. SMM will review the EIA before engaging in

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Asian Development Bank 20/4/11 TA 7295 - PRC: Energy Efficiency and Emission Reduction Project in Shandong Province an equipment/service supply contract to ensure that the EIA report contains proper measures regarding coal waste handling and disposal/reuse as properly approved by the local environmental protection bureau (EPB).

In a typical SMM coal washing plant approximately 80% of the equipments used would be manufactured by SMM. Aside from those technologies of SMM that lead the industry in the country, the SMM coal washing system would also incorporate other advanced technologies/equipments from other leading vendors in the country.

The SMM coal washing plant adopts modern coal washing technology; heavy medium coal washing technology will be used at the primary washing system. To compare with conventional primary coal washing process by cyclone, the technology features multiple advantages, including stable clean coal quality, less coal loss and high clean coal recovery. Another key technical advance of the SMM coal washing plant is SMM’s proprietary flotation technology for coal fine recovery.

A conventional flotation process includes:

Coal Slime Water  Conventional Floatation Machine Centrifuge  Fine Clean Coal

The SMM proprietary flotation system comprises the following:

Coal Slime Water → Coal Surface Improvement Device → Micro-bubble Flotation Machine → Press Filter → Fine Clean Coal

The use of the advanced SMM fine coal recovery technology can increase the fine clean coal recovery by 5% and reduce flotation medium consumption by more than 70%, reaching the world advanced level. The incremental value of the increased clean fine coal recovery alone would be able to provide over 10% annual return on the total cost of the complete system of coal washing equipments.

The initial coal washing plants tentatively include five candidate coal mines distributed in Shanxi (2), Anhui (1) and Shandong (2) provinces with a total annual coal washing capacity of 20 million tons per year (Mt/yr) and clean coal production capacity of 16.8 Mt/yr, requiring a total equipment investment of CNY38,356 million. A breakdown of the five candidate plants is provided in Table 4.

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Table 4: Summary of Initial Coal Washing Candidate Plants Net Energy SO CO Design Equipment 2 2 Candidate Saving Emission Emission Capacity Investment Plant (,000 Reduction Reduction (Mt/yr） (Million CNY) tsce/year) (t/yr) (,000 t/yr) DongDa Coal Mine Coal 8 148.56 304,729 8440.8 744,571 Washing Plant in Jincheng Yangcheng Coal Washing 2.4 50 91,419 2532.24 223,371 Plant of Jinin Mining Group Guotun Coal Washing Plant 2.6 53 99,037 2743.26 241,985 of LuNeng Group Feicheng Liangbaoshi 6 110 228,547 6330.6 558,428 Coal Mine Coal Wash Plant Jingfang Coal Mine Coal Wash Plant in 1 22 38,091 1055.1 93,071 Changzhi County, Shanxi Total 761,823 21,102 1,861,426 Source: Feasibility study report.

Energy savings from the SMM subproject mainly include the improved energy efficiency of coal fired boilers due to use of clean coal, recovery of fine coal and avoided transportation of waste coal by railway. For a total processing capacity of 20Mt/yr, the total direct and indirect energy savings were estimated to be approximately 762,000 tsce/yr, which would result in a net CO2 emission reduction of approximately 1,861,000 t/yr.

Coal washing can remove 60% - 80% inorganic sulfur in raw coal. For a total coal washing capacity of 20Mt/yr, the total removed inorganic sulfur is estimated to be over 72,000 t/yr. Assuming average sulfur removal efficiency of flue gas from coal combustion at various boilers is 85%, if the above inorganic sulfur has not be removed by coal washing, it would result in approximately 21,100 t SO2 emission per year.

Detailed description of SMM coal washing ESCO, including the schematic of a typical SMM coal washing plant, is provided in Appendix F.

4.5 INVESTMENT PLAN

The total costs required for the implementation of the three initial subprojects are estimated to be approximately $209.5 million (see Table 5). The total cost includes physical and price contingencies, and interest and other charges during implementation. More details regarding the subproject cost estimates are provided in Appendix G.

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Table 5: Program Investment Plan ($Million) Item Amount A. Base Costsa Civil Works 16.34 Purchase of Equipment 125.34 Equipment Installation 26.17 Project Management and Technical Services 17.51 Working Capital 5.84 Subtotal (A) 191.20 B. Contingencies Physical Contingencies 3.77 Price Contingencies 6.06 Subtotal (B) 9.83

C. Financing Charges During Developmentb Subtotal (C) 8.47

Total Investment (A+B+C) 209.50 a The base cost includes taxes and duties estimated at $15.11 million, including $9.74 million for ADB financed components. b Includes interest during construction and commitment charges up to the end of the grace period. Sources: Project feasibility study reports and Asian Development Bank estimates.

4.6 IMPLEMENTATION ARRANGEMENTS

4.6.1 The Project Management Office

SPG is the Executing Agency (EA) for this EE&ER Project, responsible for overall implementation of the project. The SPG has established a Project Steering Group comprising senior officials from SDRC, SFB, SEPB and SEITC to guide the PMO regarding the overall direction of the Project, and subloan selection/approval and implementation monitoring. As well, SPG will entrust a financial intermediary (FI) to assist the PMO with onlending to subprojects.

The PMO consists of representatives from SDRC, SFB, SEPB and SEITC and contract staff hired for the Project. The PMO will have one director and four deputy directors who will be responsible for overall operation of the PMO. The staff size may increase as required depending on the workload. The organization chart of the PMO is provided below.

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Asian Development Bank 20/4/11 TA 7295 - PRC: Energy Efficiency and Emission Reduction Project in Shandong Province

Shandong Provincial Government

Shandong Provincial Shandong Provincial Shandong Provincial Economic and Development and Shandong Provincial Department of Information Technology Reform Commission Finance Department Environmental Protection Commission

Project Steering Group

Project Management Office

Technical Unit Administration Unit Legal and Contract Unit Project Implementation Unit

Source: Shandong provincial government.

The main responsibilities of the PMO would include:

 Providing overall direction of the project and subloan selection/approval and implementation monitoring;

 Reviewing and assessing subproject applications according to the selection criteria and approval process for subprojects;

 Ensuring environmental and social safeguard compliance;

 Measuring and verify energy savings and emission reduction of completed subprojects; and

 Submitting all required reports to ADB and retain supporting documentation.

The PMO may contract consultants, as needed, to perform (a) independent measurement and evaluation of energy savings, (b) assistance with project implementation, and (c) CDM document preparation and verification activities. Amongst other things, the monitoring and verification by independent consultants will provided a basis for the partial rebate of the onlending interests back to the performing subborrowers.

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4.6.2 The Financial Intermediary

SPG will entrust a local bank or trust company (the FI), selected through an open competitive bidding process, through a trust agreement to be signed between SFB and the selected FI to manage the ADB loan. The FI will set up a separate special account dedicated to this FIL (escrow account) to receive the ADB loan proceeds, and onlend to the subborrowers as approved by the PMO. The subloans to be extended to subborrowers will be based on the draft subloan agreement template agreed with ADB. Periodic subloan repayments will replenish the escrow account and the FI will continue to onlend subsequent batches of subloans as approved by the PMO adopting the same procedures as for the first batch. From the same escrow account, the FI will make available to SFB amounts sufficient to ensure timely loan principal repayment, interest and other charges related to the ADB loans. Further discussion on the design of the FIL modality is provided in Chapter 5.

4.6.3 Subproject Selection Criteria

The initial three subprojects in the first batch have been selected and appraised by the ADB PPTA team. Representative subprojects have been selected from more than 40 candidate subprojects. Among those subprojects with most significant EE&ER outcomes, four have been carefully evaluated and three were recommended to be included in the first financing batch. The three initial subprojects have been selected according to the criteria set forth in Appendix H.

The PMO and FI will apply the same criteria in the selection of subsequent subprojects. In particular, future subproject batches of the Project will consider only those subprojects that can quantitatively demonstrate their impacts on reducing energy intensity, conserving energy resources, and abating total emissions of GHG and other pollutants, mainly CO2, SO2, NOx, and/or PM, using proven EE&ER technologies. The sizes of the future subprojects are expected to be smaller than those included in the first financing batch, which are amongst the largest and best selected by SPG in support of this ADB Project. Subprojects that involve land acquisition or resettlement issues will not be considered. In subsequent batches of onlending, only subloans exceeding the free limit of $15 million would require ADB’s prior approval. Subloans below the free limit need only be confirmed by ADB before disbursements can be made. For individual subloans below the free limit, ADB reserves the right to review subproject proposals and refuse financing for any subproject that does not meet the eligibility criteria outlined in Appendix H or comply with relevant ADB guidelines.

4.6.4 Procurement Plan

Procurement will be done in accordance with ADB’s Procurement Guidelines (2010, as amended from time to time). Subborrowers will be required to follow the relevant procurement rules in ADB’s Procurement Guidelines for financial intermediaries, and adopt appropriate procedures including (i) payment of reasonable prices, and (ii) fair canvassing when selecting suppliers. Procurement must be from ADB member countries. Subborrowers will be encouraged to procure goods through competitive bidding or shopping when such procedures are most appropriate in the interest of economy and efficiency. A procurement manual indicating the detailed procurement procedure that will be used under the overall project implementation will be prepared by the PMO and submitted to ADB for review and approval prior to undertaking any procurement activities including advance contracting and retroactive financing. In case of noncompliance, CEB will exercise the right to recall the subloan.

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4.6.5 Implementation of Environmental and Social Management System

Based on the readiness of the initial subprojects, in the first batch of the FIL loan, there is no need for implementation consultants. The safeguard reporting requirements of the initial subprojects have been accomplished as part of the PPTA Part A work with the exception of annual environmental and social management system (ESMS) implementation report. The nature of work, as reflected in the subproject categories, is not expected to induce any adverse environmental impacts19 during the construction period for Golden Yimeng and Lufang subprojects. As the SMM subproject uses existing manufacturing facilities to produce coal washing equipment and supplies energy conservation services, the subproject is likely to have minimal or no adverse incremental environmental impacts. Thus, the monitoring records furnished by the subproject companies as part of their domestic environmental license conditions and environmental impact assessment requirements will suffice the annual ESMS implementation report which would be forwarded by the PMO to ADB during the 2 years of construction period.

For the next batch of subprojects, the implementation of ESMS may require external technical expertise. Independent professional services will be engaged to monitor and evaluate the implementation of ESMS and will prepare and submit the monitoring/annual ESMS implementation reports regularly as specified in the ESMS and loan covenants. SPG has given assurance to engage appropriate consultants utilizing the funds in Shandong Energy Efficiency and Emission Reduction Account as described in Section 5.3.

4.6.6 Energy Conservation and Emission Reduction Monitoring Systems

The project performance will be monitored through the project performance monitoring system (PPMS). Estimated project completion date for the initial subprojects is 30 June 2015 at which point ADB review missions will be culminated; however, preparation of the monitoring reports as per Table 6 will continue between 2015 and 2025 as will be ascertained in the ADB project completion report. Performance indicators, their relevance, and monitoring practicalities have been discussed with the SPG and subborrowers during project preparation. The impact indicators, as specified in the design and monitoring framework (see Appendix D), will include (i) energy savings, (ii) emission reduction results for sulfur dioxide, (iii) participation rate of energy services companies, (iv) establishment of procedures and capacity for the PMO and financial intermediary, and (v) engagement of second batch of subprojects. At the start of project implementation, the PMO, FI and first batch subborrowers, with support from the Part B PPTA consultants, will develop comprehensive PPMS procedures to generate data systematically on project outcome, inputs and outputs of each component, as well as the agreed upon performance indicators and environmental monitoring indicators. These will be used to measure the project impact, outcome, output, and compliance with the ESMS. The PMO will (i) refine the PPMS framework, (ii) establish the baseline, (iii) confirm achievable targets, (iv) finalize the monitoring and recording arrangements, and (v) establish data collection systems and reporting procedures no later than 6 months after loan effectiveness.

19 No significant social impact is anticipated as land acquisition and adverse impacts on indigenous people have been excluded via subproject selection criteria presented in Appendix H.

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The project ESMS will be prepared based on the agreed ESMS framework and submitted to ADB prior to loan disbursement. Disaggregated baseline data for output and outcome indicators gathered during project processing will be updated and reported quarterly through the project quarterly progress reports and after each ADB review mission. These quarterly reports will provide information necessary to update ADB's project performance reporting system.20

4.6.7 Advance Contracting and Retroactive Financing

In light of the implementation schedule and specific technical requirements of the subproject proposals, the SPG and the subborrowers namely, Golden Yimeng and Lufang, have requested that project preparatory work commences under the advance contracting provisions of ADB loan funding. These companies under each subloan have also requested retroactive financing which will be up to 20% of individual subloan provided such expenses are incurred in accordance with procurement practices acceptable to ADB and not more than 12 months before the signing of the loan agreement. The government and the subborrowers have been informed that provision of advance contracting and retroactive financing does not commit ADB into financing the subprojects.

A total of one civil works and three goods contracts is proposed to be procured by Golden Yimeng and four goods contracts by Lufang through advance contracting.

4.6.8 Reporting

The SPG, with the assistance from FI and subborrower companies, will submit reports and information to ADB concerning the use of the loan proceeds, project implementation, and performance. As indicated in Table 6, the progress reports will include (i) quarterly progress reports on project implementation, (ii) annual reports on safeguard compliance, and (iii) a project completion report. Through the preparation and submission of quarterly progress reports, the PMO will report the progress made, problems encountered during the period under review, steps taken or proposed to remedy the problems, the proposed program for the planned project implementation activities, and progress expected in the following quarter. As and when each new subproject is selected in the future, the associated appraisal reports will also to be submitted to ADB.

Table 6: Summary of Key Reporting Requirements During Implementation

Name of Report/Documents Timing of Reporting

Quarterly progress reports on project implementation, Every 3 months until project completion with the fourth quarter reports serving as the annual reports for the years concerned Project completion report Within 6 months after the physical completion of the project Audited financial statements and audited Before 30 June of each year from 2012 project accounts throughout the implementation period Auditor's report (including auditor's opinion on statement of expenditures)

20 ADB’s project performance reporting system is available at: http://www.adb.org/Documents/Slideshows/PPMS/default.asp?p=evaltool

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Categorization, audit and subproject selection As and when each subproject under Report the financial intermediation loan is selected

Environmental impact assessment and/or As and when each subproject under initial environmental examination reports the financial intermediation loan is selected

Annual ESMS implementation report Once a year for each subproject ESMS = environmental and social management system.

4.6.9 Investment Program Review

ADB, the Steering Group and the PMO, and the Government will review project implementation jointly at least once a year. In addition, ADB and the government will undertake a comprehensive midterm review 3 years after the start of project implementation. This midterm review will include a detailed evaluation of the scope, implementation arrangements, achievement of scheduled targets, and progress on engaging second batch of subprojects and roll over of funds. Feedback from the PPMS activities will be analyzed. Within 6 months of physical completion of the Project, SPG will submit a project completion report to ADB21.

4.6.10 Anticorruption Policy

ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the Government, SPG, the PMO, and the FI. Consistent with its commitment to good governance, accountability, and transparency, ADB reserves the right to investigate, directly or through its agents, any alleged corrupt, fraudulent, collusive, or coercive practices relating to the Investment Program. To support these efforts, relevant provisions of ADB’s Anticorruption Policy (1998) are included in the loan regulations and bidding documents under the Investment Program. In particular, all contracts financed by ADB in connection with the Investment Program shall include provisions specifying the right of ADB to audit and examine the records and accounts of the FI, the PMO, subborrowers, and all contractors, suppliers, consultants, and other service providers as they relate to the Investment Program. In addition, the following characteristics of the Investment Program promote transparency and strengthen governance: (i) dual scrutiny of the subprojects (technical, economic, environmental, and social by the PMO and financial by FI); (ii) the use of trust agreement (between SFB and FI), and subloan and subproject agreements; and (iii) an information campaign to be carried out by the PMO to inform enterprises and other large energy consumers about the Investment Program and their entitlements.

21 Project completion report format available at: http://www.adb.org/Consulting/consultants- toolkits/PCR-Public-Sector-Landscape.rar

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5. MODIFIED FINANCIAL INTERMEDIATION MODALITY

5.1 RATIONALE AND DESIGN OF THE MODIFIED FINANCIAL INTERMEDIATION MODALITY

The existing industrial energy efficiency financing mechanisms in Shandong have mainly benefited small projects, primarily through energy service company (ESCO) involvement. While the ESCO concept has been operative in PRC since 1998 its implementation was rather slow and limited to small-scale industrial energy efficiency improvements, e.g., retrofitting of small boilers, pump and motor drives, lighting, air conditioners, and/or transformers. Accordingly, there is a large financing gap for medium- and large-sized22 energy conservation projects that involves whole or part of an industrial manufacturing process for a particular industry. There are three key barriers that have impeded the investment: (i) lack of familiarity with the range of available energy conservation technologies, combined with the enterprise’s perception of causing production interruptions/loss of revenues; (ii) lack of additional revenue generation by energy efficiency projects making it difficult for banks to assess the cash flow benefits and forgo collaterals for significant lending; and (iii) lack of capacity for proper evaluation and consequent risk assignments for energy conservation investments by domestic commercial banks. Limited market-based incentive mechanisms to reward investors in reducing emissions through energy efficiency also discourage investors. Due to smaller emission reductions per transaction, large and scattered investments, multiple technologies and processes, the risks are high in seeking clean development mechanism registration for the projects. Preferred loans from the government and IFI are hence in need for EE&ER projects despite the typically high investment return on such projects.

In addition, the design of the Shandong EE&ER FIL has taken into account a number of other factors, as outlined below:

 Where the investment decision is made to proceed with an EE&ER subproject, the available project preparation time for EE&ER is usually short as some of the project owners may have already been under regulatory pressure from the local government to resolve outstanding emission or energy efficiency issues. As well, EE&ER subprojects typically do not require land acquisition and settlement or extensive government approvals. For example, most retrofit projects may require only simplified EIA form, if at all, to get approved in a few weeks. (In comparison, the regulatory approval process of a new industrial construction project may take one year, if not longer.) The implementation period of EE&ER subprojects is usually short as they typically employ matured technologies and equipments. For example, a waste heat recovery and generation system can be finished in a few months;

22 The size of an energy efficiency investment is defined by the estimated investment cost of a single energy efficiency technology intervention. The targeted energy efficiency investments of the proposed project range from $10 million and above, compared with small- sized investments in the range of $1 to $5 million or less. The size of an industrial enterprise is defined by its annual revenues. According to the China State Statistical Bureau (2008 Guidelines), enterprises are defined as medium-sized if their annual revenues are in the range of CNY30 million to CNY300 million (approximately $4.4 million to $40 million), and large-sized if in excess of CNY300 million.

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 The return on EE&ER subprojects is typically immediate as they require no marketing, no sales, after commissioning. The investment payback periods of EE&ER subprojects are usually short (generally less than 4-6 years. Including a typical construction period of 0.5 year to 1 year, the required loan tenure for EE&ER subproject is typically 5 to 7 years, if not shorter;

 Most EE&ER projects are small investments. The total investments are usually less than $20 million and the size of subloan from the ADB portion may be less than $10 million, which are much smaller than traditional ADB loans for infrastructural and environment projects. However, the initial three subprojects under this FIL are exceptionally large, with the largest proposed ADB loan amount reaching $40 million. Largely due to the full support of SPG to this ADB Project, all three initial subprojects selected and mobilized by the local governments are the leaders in their individual sectors in Shandong province, and leading players in the country. In part because of the large scales of the first batch subprojects, the local governments are willing to extend the guaranty required for the ADB loans to the private enterprises, which is typically a barrier for IFIs to provide preferred loans to private enterprises. The average size of subsequent batches of subloans can be expected to be smaller and is likely to be less than $10 million, if not much smaller; and

 Most potential EE&ER subprojects are expected to be located in relatively remote parts of Shandong because they tend to be associated with energy intensive (and typically high pollution) sectors. Outside of major cities, direct services by IFIs to small projects will be highly costly and inefficient. Given expected numerous small subprojects scattering amongst relatively remote areas, ADB’s direct supervision of procurement, disbursement, and subproject approval will not be efficient nor effective under a standard ADB FIL modality.

A modified FIL modality is hence proposed with simplified subproject appraisal and strengthened implementation supervision to give SPG the needed flexibility to meet the short turnaround time required for EE&ER activities. In particular, the Modified FIL modality was chosen to (i) allow multiple rollover of ADB loan amount, thus, providing larger investments for energy efficiency over the loan tenor, (ii) build knowledge and capacity of provincial government and domestic financial institution in evaluation and risk assignments on energy efficiency transactions, (iii) reduce transaction complexities and costs due to familiarity and experience gained by both the PMO and financial intermediary from the initial subprojects, and (iv) enhance governance and improve safeguard compliance for energy efficiency investments beyond the first batch of subprojects.

A detailed comparison between a standard ADB FIL modality and the proposed modified FIL modality is provided in Appendix I to help explain the rationale for the use of modified FIL modality for the Shandong EE&ER Project. The relationships, fund flow, information flow and guaranty flow between the stakeholders under the modified FIL modality are illustrated in the chart below.

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Under the modified FIL modality, the PMO’s functions extend into the financial management of the Project to include:

 preparing the annual contract awards and disbursement projections;

 requesting budgetary allocations for counterpart funds;

 preparing withdrawal applications and sending the withdrawal applications to ADB; and

 collecting supporting documents for the project expenditures incurred by the subborrowers. For expenditures eligible under retroactive financing, the subborrower will submit its claim to PMO.

The FI will provide the custody service and administrate the escrow account to be established to receive ADB loan proceeds. The FI will onlend to financially viable EE&ER subprojects approved by the PMO. Repayments or partial repayments of subloans, net of transfers to SPG for servicing the ADB loan, will be used for further onlending. By law and under regulatory oversight, the FI is required to administer the funds according to the terms of the escrow account management agreement and may not commingle the funds with other funds. Unlike a normal commercial account, the escrow account will be kept distinct from its own assets and debts, which offers protection against adverse results from other financial operations of the FI. This will help SPG ensure that ADB loan proceeds are only used to implement EE&ER subprojects and not be exposed to other banking risks.

Under the modified FIL modality, the FI will assist the PMO in the following administrative functions:

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 Assist the project management office (PMO) with onlending to subborrowers;  Conduct financial due diligence on new subprojects and creditworthiness analysis on the new subproject applicants;  Recommend to PMO in approving or rejecting subproject applications from financial assessment aspect;  Manage cash flows on disbursement, interest payment and principal processes and administering subloan portfolio;  Manage counter-guarantees, securitization and collateral issued;  Manage exchange of foreign and domestic currencies;  Ensure accounts are audited yearly;  Monitor nonperforming loans; and  Submit monthly report to the PMO.

Where/when appropriate, the FI may provide co-financing of approved new subprojects.

ADB generally allows PMO and FI to enter into subloans meeting agreed criteria without submitting subloan proposals to ADB for amounts up to the agreed free limit. The requirement of a free limit, above which subloan proposals need to be submitted by the PMO to ADB for prior approval, enables ADB to satisfy itself on the quality of the PMO’s appraisal of projects and to advise on appraisal techniques and methodology for major projects. The free limit is US$15 millions in this case.

5.2 THE FINANCIAL INTERMEDIARY

ADB’s Operations Manual23 defines and establishes the criteria for eligible financial intermediaries that onlend funds under the FIL modality. These include: (i) financial soundness; (ii) adequate credit and risk financial management practices; (iii) compliance with prudential regulations; (iv) acceptable corporate and financial management practices; (v) sound business objectives and strategy; (vi) autonomy in lending and pricing decisions; and (vii) adequate policies, systems and procedures to assess and monitor the economic, social, and environmental impacts of subprojects. In addition, financial intermediaries should have or develop capacity to mobilize domestic resources. In the past, financial intermediaries have usually been commercial or development banks and the requirements were structured accordingly.

For this Investment Program, China Everbright Bank (CEB) has been selected by SFB as the financial intermediary to onlend to subborrowers through an open competitive bidding process conducted in May 2010. CEB Jinan branch will be responsible for managing the loan account and onlending to subborrowers. Accordingly, due diligence assessment was conducted. As indicated in Appendix J, due diligence assessment of CEB Jinan branch concluded that it is financially sound, has adequate risk and management policies, acceptable corporate and financial management practices, and complies with regulatory requirements.

The FIL is designed to revolve the ADB funding by establishing a separate escrow revolving account with the selected financial intermediary. The involvement of China Everbright Bank (CEB), a commercial bank, in rolling over the fund will bring in sound banking expertise and governance in energy efficiency lending. It will also strengthen cooperation between the government agency (the PMO) and the domestic financial

23 ADB. 2003. Operations Manual. Section D6/BP: Financial Intermediation Loans. Manila.

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5.3 SPECIFIC TERMS OF THE FIL MODALITY

Tenures of the Loan and Subloans: To maximize the benefit from the revolving nature of the financing, the term of each subloan will be no more than 6 years, including a grace period of 2 years. The loan repayment term for all subprojects will match the payback period for each batch. Only subprojects satisfying the selection criteria presented in Appendix H and technically appraised by the PMO with the assistance of CEB will be financed for subsequent batches.

Commercial banks in the PRC do not have the complete freedom to set interest rates. However, the People’s Bank of China allows interest rates to deviate from the prime rate within a narrow band to reflect the credit risk of the borrower. The current prime rate in the PRC for the same tenor of the subloan is 5.94%. With the 10% discount, the interest rate on the subloan will be about 5.35%. The interest differential on the subloan will therefore be about 2.75%, if the equivalent fixed interest swap rate on the ADB loan is considered. The SFB will bear the risks of currency exchange and interest rate fluctuations.

Rates of the Loan and Subloans: SPG has proposed to keep the ADB loan at variable rate based on the 6-month LIBOR plus 0.3% ADB premium (i.e. 0.5%+0.3% at present). The PMO will then onlend to subprojects at a lowest rate permissible by the People’s Bank of China for a commercial loan, which would be 10% lower the current prime rate of the same term.24 In this case, the PMO and ADB agree that the FI will onlend to those subborrowers at 5+ years loan at the current fixed rate of 5.36%, a 10% discount from the current central bank prime rate of 5.94% for commercial loans. The spread of interest rates is hence 4.66% at present and may be narrower in the future depending on the financial market fluctuation. The SPG may decide whether/when and how to swap the variable rate loan into a fixed rate loan, if so desired. Hence the risk of rate fluctuation should be borne by SPG.

Escrow Revolving Account: To ensure that ADB loan proceeds, as well as interest payments and principal repayments from the subborrowers are not commingled with the other funds being administered by CEB, a separate escrow revolving account will be established and maintained by CEB for all transactions related to the project and administration of the FIL. This will ensure that the account is kept distinct from CEB’s own assets and provide protection against adverse results from other CEB financial operations. Since the loan proceeds will not be relent to CEB, the requirement to relend ADB proceeds to a financial intermediary on terms no more favorable than ordinary capital resources terms is not applicable. Rather than relending the loan proceeds, the funds will be made available to CEB under an escrow arrangement between SFB and CEB.

Shandong Energy Efficiency and Emission Reduction Account: SFB will establish a Shandong Energy Efficiency and Emission Reduction Account at CEB to provide support for the Project. The account will principally be funded from the interest differential between the FIL onlending rate to the subborrowers and ADB’s

24 Commercial banks in PRC do not have the complete freedom to set interest rates. However, the People’s Bank of China allows interest rates to deviate from the prime within a narrow band to reflect the credit risk of the borrower.

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(i) An average of 50% of the interest spread will be rebated to the subborrowers as a reward for actual energy savings achieved, subject to monitoring and verification by independent consultants; and

(ii) The other 50% of the interest spread will be used to pay for the financial intermediary management fees (approximately 0.2% per annum of the ADB loan amount), and PMO administration costs including procurement of independent consultants for professional services based on the actual amount. These professional services will include (a) appraisal and selection of future subprojects; (b) subproject capacity building, where appropriate; (c) implementation of ADB monitoring and reporting requirements for the project; (d) subproject performance tracking and verification in terms of energy savings and emission reductions; and (e) production of an operations manual as a reference point for future energy efficiency investments in order to replicate the experience gained by the PMO and financial intermediary. To meet these critical needs, a separate PMO account can be opened in accordance with SFB’s procedure.

Disbursement: Disbursements will be in accordance with ADB’s Loan Disbursement Handbook (2007, as amended from time to time)25 and detailed arrangement agreed upon between the government and ADB. The loan proceeds will be paid through SFB’s account that will be setup with the CEB upon loan effectiveness. Such loan proceeds will be transferred from SFB to the escrow revolving account with CEB within five working days of receipt of funds by SFB from ADB following necessary domestic procedures. The escrow account will be managed by CEB. The initial withdrawal request for a particular subproject loan will be supported by a withdrawal application, and certification from SFB that the subloan and subproject agreements for the subproject have been executed between the PMO, CEB, and the related subborrower, respectively, and include terms and conditions specified in related legal agreements with ADB, and are legally binding upon the parties. This certification will be a condition for the initial disbursement for each subborower. Each withdrawal request needs to be supported by a summary sheet using simultaneous application for subloan approval and withdrawal (SAW) procedure and the bank statements (only after the initial withdrawal) for the SFB and escrow revolving accounts, for the corresponding period as indicated in the withdrawal application, submitted to monitor adherence to the requirements of transferring from the SFB account to and from the escrow revolving account within five working days of receipt of funds by SFB from ADB following necessary domestic procedures. For subloans in excess of the free limit of $15,000,000, copies of the subloan and subproject agreements should be submitted together with the SAW statement. Subloans in excess of the free limit should be approved by ADB pursuant to the terms of the project agreement [Section 2.02(b)] prior to requesting withdrawal. Subloan below the free limit need only be confirmed by ADB before disbursement can be made. The disbursements under each subloan may be in several installments based on the readiness of the subproject.

25 Available at: http://www.adb.org/Documents/Handbooks/Loan Disbursement/loan- disbursement-final.pdf

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Withdrawal applications must be signed by authorized signatories of the executing agency and submitted to ADB. Withdrawal applications must be sequentially numbered starting with the number one. Counterpart funds advanced to projects will be held in a Government Counterpart Funds/Project Account known as Shandong Energy Efficiency and Emission Reduction Account.

The Government and SPG have agreed that no withdrawals will be made from the loan account in respect of any subproject until the following conditions are met: (i) SFB has certified to ADB that the subproject agreement and subloan agreement related to any such subproject, including the terms and conditions satisfactory to ADB, have been duly executed and delivered on behalf of CEB, SFB acting on behalf of SPG, and the subborrower, and have become fully effective and binding upon the parties thereto in accordance with their terms; and (ii) SPG has certified to ADB that the ESMS for the project, as prepared by the PMO and approved by ADB, has been endorsed and adopted by the PMO.

Management Fee: The financial intermediary will be paid management fees by SFB for administrating the FIL and its interest will be protected through the escrow revolving account management agreement between SFB and the financial intermediary.

Guaranty and Insurance: The guaranty of the initial three subloans is provided to ADB through the Government. The FI shall require sufficient guaranties or collaterals for all future subloans.

Accounting: SPG, CEB, PMO, and each subborrower will maintain separate accounts and records by funding source for all expenditures incurred on the Project. CEB will submit to SPG and the PMO monthly financial reports. SPG will compile the consolidated project accounts and related financial statements. The EA and the IAs will maintain separate project accounts and records by funding source for all expenditures incurred on the Project. Project accounts will follow international accounting principles and practices prescribed by the Accounting Law of the PRC.

Auditing: SPG will cause the detailed consolidated project accounts to be audited in accordance with international standards on auditing by an auditor acceptable to ADB. The audited accounts will be submitted in the English language to ADB within 6 months of the end of the fiscal year by the executing agency. The annual audit report will include a separate audit opinion on the SFB account, the escrow revolving account, and the Shandong Energy Efficiency and Emission Reduction account, the use of the loan proceeds, and compliance with the financial covenants of the loan agreement. The SPG and PMO have been made aware of ADB’s policy on delayed submission, and the requirements for satisfactory and acceptable quality of the audited accounts. ADB reserves the right to verify the project's financial accounts to confirm that the share of ADB’s financing is used in accordance with ADB’s policies and procedures.

5.4 FINANCING PLAN

The Government of the PRC has requested financing of up to an equivalent of $100,000,000 from ADB’s ordinary capital resources to help finance selected energy efficiency projects using the FIL modality including taxes, duties and goods related transportation and insurance costs. Provisions of the loan regulations applicable to

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Asian Development Bank 20/4/11 TA 7295 - PRC: Energy Efficiency and Emission Reduction Project in Shandong Province the loan based on the London interbank offered rate (LIBOR)26 will apply. The loan will have a 15-year term including a grace period of 10 years, an interest rate determined in accordance with ADB’s LIBOR-based lending facility, an applicable commitment charge, and such other terms and conditions set forth in the loan and project agreements. The government has the option to choose between eligible currencies and the interest rate regime. The government has provided ADB with (i) the reasons for its decision to borrow under ADB’s LIBOR-based lending facility on the basis of these terms and conditions, and (ii) an undertaking that these choices were its own independent decision and not made in reliance on any communication or advice from ADB. The longer grace period is essential to maximize the benefits of FIL so that the full amount of the loan is available for relending to a greater number of industries resulting into increased energy savings and emissions reduction. A similar approach was adopted for the Guangdong Energy Efficiency and Environment Improvement Investment Program.27

5.4.1 Financing Plan for Initial Subprojects

Initially, the ADB loan will be onlent to the first batch of selected subprojects through CEB. Subsequently, CEB will onlend the repayment proceeds to the eligible subborrowers via the escrow account.28 Financing for each subproject requires at least 25%29 equity from each sponsor of the subborrower.

The three initial subprojects have be identified, appraised and recommended for ADB approval by ADB appointed PPTA consultants. The financing plan for the initial three subprojects is presented in Table 6. As indicated in Table 6, the whole FIL of US$100 million has been committed to the initial subprojects, which finances over 47.7% of the total investment of approximately $209.5 million. The subborrowers have committed to contribute 30.0% equity to the total investment. The balance of 22.3% will be financed by domestic loans. The funding for subsequent subloans will come from the repayments of the first batch subprojects, starting after the 2-year grace period.

26 ADB. 2001. Ordinary Operations Loan Regulations Applicable to LIBOR-Based Loans Made from ADB's Ordinary Capital Resources. Manila. 27 ADB. 2008. Report and Recommendation of the President to the Board of Directors: Proposed Multitranche Financing Facility and Administration of Grant for the People's Republic of China for Guangdong Energy Efficiency and Environment Improvement Investment Program. Manila (MFF 0020-PRC, approved on 4 June, for $100,000,000). 28 Proceeds from loan repayments of earlier borrowers will be rolled over to provide funds for new subborrowers meeting the eligibility criteria. 29 Subborrower’s sponsor equity of at least 25% forms part of the financial selection criteria for the project.

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Table 6: Financing Plan (in US$)

Golden Lufang SMM All Subprojects Yimeng Items % in $ '000 $ '000 $ '000 $ '000 Total Equity – Subproject Company 19,145 22,699 21,094 62,938 30.04% Long-Term Debts ADB Loan 32,000 28,000 40,000 100,000 47.73% CNY Loan 13, 989 26,000 6,572 46,562 22.23% Total 65,134 76,699 67,666 209,499 100.0%

5.4.2 Revolving Effect of the $100 Million FIL

Under the Modified FIL Modality, the EA can use subloan repayments to finance future subprojects selected in subsequent batches. The revolving financing will amplify the benefit of energy savings and emission reductions through the 15 years tenure. In this case, the FI can collect on average US$25 million principal repayments per year from the initial three subborrowers, starting 2013. Hence, the PMO can select 2 to 4 subprojects each year for a subsequent batch of subloans from 2013 onward. Based on the assumptions outlined in Table 7, the ADB FIL of US $100 million can be amplified to approximately US$ 308 million within its tenure of 15 years. The detailed simulation table for the revolving FIL is provided in Appendix K.

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Table 7: Effect of $100 Million Revolving FILa Table 7A: Basic

Assumptions ADB Loan Amount Interest Rate of ADB Subloan Tenure 3.57% (US$ million) 100 6 Loan after Swap (Yrs)

ADB Loan Tenure Subloan Grace Interest of Subloan 5.346% 15 1-2 (Yrs) Period (Yrs)

ADB Loan Grace Commitment Fee PMO Management 0.50% 10 0.15% Period (Yrs) of ADB Fee

FI Account Interest Spread 0.20% 50% Management Fee Rebate to Subborrower Table 7B: Key

Results Total Interest Total Loan from Payments to EA Loan Tenure 2011-2025 ADB (US$ million) $100.0 66.73 (US$ million)

Total On-lending Total Interest Total No. of Batches through FI Payments to ADB 45.00 9 $307.9 (US$ million) (US$ million)

Total Revolving Total Interest No. of subprojects Funding Ratio of Spread Rebate to 23+ 307.9% 9.84 financed via FILs FILs Subborrowers (US$ million) Total Investment Total Management Average Actual to EE&ER 4.56% $615.8 Fee Available to 6.30 Interest Rate Subprojects PMO (US$ million) (US$ million) Total Account Total Investment Management Fee Ratio Cofinanced 615.8% 2.52 to FI (US$ million) by ADB Loan

Balance in EA after Full 3.08 Repayment (US$ million) Note: a - Based on a conservative assumption that ADB swaps the 6 months LIBOR-based variable rate at 0.5% to 7 years fixed rate at 3.27%, plus 0.3% ADB premium, and then lend to PMO at 3.57%.

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6. EXECUTING AGENCY CAPACITY BUILDING FOR ENERGY EFFICIENCY IMPROVEMENT

6.1 EA CAPACITY BUILDING NEEDS

The needs for capacity building identified through the Part A PPTA include provisions of:

 Training to PMO and FI staff in subproject project selection and appraisal;  Training to PMO and FI staff in financial management, including procurement and disbursement procedures; and  Training to PMO staff, PMO consultants and sub-borrowers in project performance monitoring.

At the start of project implementation, an urgent need for PMO capacity building would be financial management training to the PMO and FI staff, especially in procurement and disbursement procedures.

Early into project implementation, the PMO, FI and first batch subborrowers are expected to develop comprehensive project performance monitoring procedures in order to generate data systematically on project outcome, inputs and outputs of each component, as well as the agreed upon performance indicators and environmental monitoring indicators. This would be another area that the PMO/FI staff and sub- borrowers may require training and support.

As part of the loan processing an ESMS arrangement has been drafted to guide SPG, the EA, to develop their own ESMS as SPG takes on the responsibility of appraising and approving the future subprojects under the FIL. The PMO is required to finalize the project ESMS prior to any loan disbursement based on the agreed ESMS framework and submit to ADB for review. In order to ensure that lessons learned from the first batch are propagated in an efficient manner and quality is maintained, ADB, through its part B PPTA consultants, will assist the PMO in developing a comprehensive and simplified procedure for ESMS implementation including various reporting requirements.

The safeguard reporting requirements of the initial subprojects have been accomplished as part of part A PPTA with the exception of annual ESMS implementation report. However, for the next batch of subprojects, the implementation of ESMS may require external technical expertise. Independent professional services will be engaged to monitor and evaluate the implementation of ESMS and to prepare and submit the monitoring/annual ESMS implementation reports regularly as specified in the ESMS and loan covenants. Under the proposed FIL scheme, a designated Shandong energy efficiency and emission reduction account will be set up by SFB at the financial intermediary bank to retain all the interest spread between of the relending rate from ADB to SFB and the onlending rate from FI to the subprojects. A portion of the retained fund will be used for retaining independent implementation consultants to supplement the PMO’s shortage of expertise in ESMS.

Another key responsibility of the PMO/FI is the appraisal of subsequent batches of subprojects, including emission reduction assessment. Based on the observations made during the initial subproject appraisal process, it appeared that the subproject sponsors were lack of capability and/or resource for assessment of emission reduction within large industrial facilities, which tended to have complex baselines.

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Within the Chinese domestic system, the project sponsor is required to use licensed design institutes to prepare the feasibility studies. Though generally good at project cost estimates and energy saving assessment, design institutes would not necessarily have sufficient expertise in emission reduction assessment. Therefore, another key area of PMO capability building training would be on emission reduction assessment, which would help prepare PMO staff for the upcoming subproject appraisal.

6.2 CAPACITY BUILDING TECHNICAL ASSISTANCE

Successful implementation of the Project would require sound project management and financial management. The Part B PPTA has been scheduled to help strengthen the project management and financial management of the PMO, FI and subborrowers through a series of training seminars and workshops, covering the following areas:

(a) project management procedures and requirements, including procurement and disbursement procedures;

(b) energy efficiency analysis and emission reduction assessment;

(c) energy saving and emission reduction monitoring/verification.

As discussed above, the part B PPTA consultants will assist the PMO in developing a comprehensive and simplified procedure for ESMS implementation including various reporting requirements. A training program will also be delivered on the ESMS implementation to the relevant SPG staff responsible for the management of ESMS.

To help ensure smooth rollover of the repayments from the initial subprojects (starting 2013) to the subsequent subprojects, it has been recognized that it is necessary for the PMO to kick-start the selection and appraisal of the second batch subprojects, presumably 1-2 subprojects, as early as possible while the Part B PPTA team is still in place to assist with the appraisal. It is envisaged that through the process the PMO and FI staff will gain on-the-job training on subproject appraisal in general and energy saving and emission reduction assessments in particular.

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7. INVESTMENT PROGRAM BENEFITS, IMPACTS, ASSUMPTIONS AND RISKS

Technical, economic, financial, environmental, and social assessments of the three initial subprojects have been carried out and the results are used to project the benefits and impacts of the initial subprojects.

7.1 ENVIRONMENTAL BENEFITS AND IMPACTS

An environmental assessment and review framework prepared for the Investment Program (Appendix L) concludes that the initial subprojects have notable energy conservation and emission reduction benefits.

The Project is classified as environmental category F1, which involves lending through a financial intermediary. The initial three subprojects have been assessed and are classified as environmental categories B and C in accordance with the ADB’s Environment Policy (2002) and Environmental Assessment Guidelines (2003). Amongst them, the SMM coal washing service subproject is classified as environmental category C because the role of SMM is limited to supply of advanced coal washing technology and equipment, coal washing plant management, technical services for coal washing projects located in Shandong and other provinces in China. For each coal washing plant, the coal mine company will be responsible for the preparation of a full EIA report and application for EIA approval, including proper waste management plan. The other two subprojects are classified as environmental category B and they only require simple environmental assessments.

As discussed in detail in Appendix E, substantial environmental benefits including potential for energy efficiency improvements and GHG emission reductions are anticipated in addition to potential eligibility for clean development mechanism. A summary of the calculated emission reduction figures and energy conservation for the initial three subprojects has been provided in Table 1. Full implementation of the initial three subprojects alone will achieve annual energy saving of approximately 916,000 tsce/yr, and annual emission reduction of approximately 2,680,000 tons CO2, 22,100 tons SO2, 7,400 tons NOx, 2,700 tons CO and 1,800 tons PM, from 2013.

With the implementation of subsequent batches of subprojects under this FIL, it is expected that the Project will result in substantially more energy savings and emission reductions in Shandong province. Based on ADB’s Workbook on Economic Evaluation of Environmental Impacts, the total economic value of the quantifiable environmental benefits from reduced air emissions is estimated to be approximately $213 million (CNY1,446 million) per annum from the three initial subprojects (see Appendix M). Unquantifiable environmental benefits are also significant.

7.2 ECONOMIC ANALYSIS

7.2.1 Economic Benefits

The economic benefits of the three initial subprojects were calculated to assess the economic viability of the subprojects. The economic analyses were performed according to ADB’s Guidelines for Economic Analysis of Projects (1997). The economic costs include capital costs, and operation and maintenance costs. Appropriate conversion factors were used to convert financial values into economic values. The economic benefits mainly include the savings of electricity and coal and

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Asian Development Bank 20/4/11 TA 7295 - PRC: Energy Efficiency and Emission Reduction Project in Shandong Province sales of by-products (e.g. electricity, heat/steam, organic fertilizers and sulfuric acid). The environmental benefits of avoided air emissions were also considered to account for prevailing price of GHG emission reduction credits under CDM and shadow exchanges of SO2, NOx and PM emissions. Details of the economic analysis of the initial three subprojects are provided in Appendix M.

The estimated economic internal rate of return (EIRR) and economic net present values (ENPV) for the three subprojects are summarized in Table 8. The calculated EIRRs for the three subprojects range from 20.7% to 37.5% without the environmental benefits and 37.5% to 48.7% with the environmental benefits. The overall EIRR for the whole subprojects is 28.9% without environmental benefits and 42.4% when environmental benefits are included. Sensitivity analysis presented in Appendix M indicates that even under an unlikely combination of cost overrun, benefit decline and project delay, the calculated EIRR would still be well above the generic target of 12%.

Table 8: Summary of EIRR and ENPV

Golden Subproject Yimeng SMM Lufang Whole Project (CNY Million) Without Environmental Benefits EIRR (%) 28.0% 20.7% 37.5% 28.9% ENPV (CNY Million) 381.6 204.2 771.7 1167.0 With Environmental Benefits EIRR (%) 37.5% 48.7% 40.3% 42.4% ENPV (CNY Million) 654.9 1,085.8 872.4 2,613.1 Note: Total Environmental Benefit (CNY Million) = 2613.1 - 1167.0 = 1446.1 Source: ADB Estimates.

7.2.2 Demonstration Values

All three initial subprojects selected for the first batch financing contain/supplement large scale applications of the state-of-the-art energy efficiency/renewable energy technologies with high demonstrative values in and beyond Shandong. In particular,

 The advanced coal fine recovery by membrane press filter in a typical SMM coal washing plant is a listed technology in the 2008 National List of Priority Energy Saving Technologies (No. 3). The candidate coal washing plants under the SMM ESCO is distributed in three major coal production provinces in the country;

 The flue gas heat recovery for power generation and heat recovery during sulfuric acid absorption by Lufang are listed technologies in the 2008 National List of Priority Energy Saving Technologies (No. 20 and No. 32). More importantly the proposed heat recovery and emission reduction subproject supplements and supports the first full scale “Zero Coal” copper ore smelting furnace using the Oxygen Bottom Blown Smelting technology, which leads the industry globally with high energy efficiency and low carbon emission and has been identified by the State Council in 2009 as a national backbone technology. The Lufang plant will set the new market entry standard for future copper

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smelters with profound impact on the EE&ER efforts in the copper production industry;and

 The Golden Yimeng subproject contains two listed technologies in the 2008 National List of Priority Energy Saving Technologies, including (a) anaerobic methane capturing from alcoholic fermentation wastewater for power generation and heat supply (No. 37) and (b) large-scale application of solar thermal heat collection system in industrial systems (No. 42). As the top Cassava root fermentation group in China, Golden Yimeng operates facilities in Jiangsu province in addition to the main facilities in Shandong to produce industrial alcohols, organic aldehydes and acetate esters. As a component of this subprojects, the wasted biomass will be used to further produce organic/composite fertilizers. Further, Golden Yimeng operates a Cassava root production base in Thailand and imports Cassava root from the Southeast Asia as fermentation raw materials, which are biomass growing on non-agricultural hilly lands. The proposed Golden Yimeng subproject hence help complete the whole production chain to represent a template of circular economy with its impact extending well beyond Shandong.

The demonstration projects will have a multiplier effect and contribute to energy conservation and environmental improvement as well as improvement in productivities in their respective subsectors. However, these benefits could not be quantified because of methodological difficulties and lack of data. Therefore, the projected EIRRs, albeit already high, are considered highly conservative, as they take into account only the quantifiable benefits.

7.3 FINANCIAL ANALYSIS

7.3.1 Financial Performance of the Subborowers

The subborowers of the three initial subprojects, Golden Yimeng, Lufang and SMM, are leaders in their respective industrial subsectors. The key financial performance indexes of these three subborrowers for the past four years (2006-2009) have been reviewed based on the audited financial statements provided by the subborrowers. All three companies have substantial equities and rights to support substantial debt financing. In particular,

 Golden Yimeng is a large private-owned enterprise group and a leading supplier of acetate esters, organic aldehydes, composite fertilizers and fermented alcohol in China. Its total assets approached CNY 2.0 billion at the end of 2009 (with a debt-asset ratio of 64.4%) and sale revenues exceeded CNY 2.1 billion in 2009, with average annual expansion of 30% in the last 4 years. However, its sales growth rate has slowed down recently mainly due to the adverse impact of the global financial crisis. This led to a declining net profit rate on equity (after corporate income taxes), which was averaged at 11.8%. It is expected that the net profit rate on equity can stay at around 8% in the near future, because of steady recovery of the Chinese domestic market;

 Lufang is a wholly-owned subsidiary of Dongying FangYuan Non-Ferrous Metals Co. Ltd, which was established in 1998 and is reportedly the number one private–owned industrial enterprise in China with a total revenue of over CNY12.0 billion in 2008. Lufang was established in 2006 and started production in 2008. Its sales revenues was over CNY 3.0 billion in 2009, and its total assets have accumulated to nearly CNY 1.5 billion by the end of 2009, with a

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very low debt-asset ratio of 25.4%. Lufang’s net profit rate on equity was 21% in 2009 because its OBBF smelter can utilize inexpensive ores and its products (primarily copper) has been under high demand; and

 The SMM’s data does not cover the second half of 2009. With a long history of over 50 years, SMM has approximately 2,800 employees and specializes in developing, producing and distributing mining machineries and construction equipments. Its sales revenues was estimated to be around CNY 0.9 billion in 2009 and its total assets were CNY 1.2 billion by the end of 2008 with a debt- asset ratio of 66.2%. Its net profit rate on equity was 14.2% in 2008.

As major employers and tax payers in their respective city/counties, these three companies have obtained strong local government supports for investing in the proposed EE&ER subprojects, which would also contribute to the local EE&ER targets. The local governments have committed to provide guaranties to SPG for the subloans from the ADB FIL.

An assessment based on the completed financial management assessment questionnaire, supplemented by the submission of relevant documents and interviews, was done for each subproject sponsor. The assessment indicates that accrual basis accounting and PRC business accounting standards are followed. The accounting procedures currently used by the companies are aligned with the regulations and policies issued by the Ministry of Finance, and are considered effective and adequate for the project. The functions related to the authorization, transaction, recording, and asset management are well separated. Computerized accounting system is used and operated by the accounting staff. A complete set of accounting procedures for recording and processing transactions is in place in companies. Internal control is effective. A rigorous budgeting system is uniformly implemented. The budgets cover both financial and physical targets and include sufficient details of the company’s activities. The same accounting systems and procedures will be used for their respective subproject. The companies have an internal audit department, of which the internal auditors are designated to conduct internal audit and report to the board periodically or as needed. Financial statements are regularly audited by external auditors. The audit reports are usually issued within 2 months after the end of the fiscal year or not later than the mandatory submission period. The companies’ organizational structures are generally adequate for the project. The current accounting department and its staff are suitable and adequate for the project. Additionally, in the case of Golden Yimeng and Lufang, they have organized a full team on project management including procurement, disbursement, and construction management, among their functions.

7.3.2 Key Financial Performance Indicators of Initial Subprojects

The financial net present values (FNPV) and financial internal rates of return (FIRR) were calculated for each of the three initial subprojects as well as for all the three subprojects combined (see Table 9). Detailed financial analysis of the three initial subprojects, together with financial assessments of the three subborrowers, are provided in Appendix N. The analysis has been performed in accordance with the ADB guidelines in Financial Management and Analysis of Projects (2005). To be conservative, the potential revenue from the sales of the certified emission reduction credits (CERs) under the CDM is not included in the FIRR calculation.

As indicated in Table 9, the combined FNPV for the three subprojects is estimated to be $314.7 million. The calculated FIRRs for the three subprojects range from 20.5%

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Table 9: Key Financial Performance Indicators FIRR FNPV SPB Subprojects DSCR (%) ($ million) (Yr) Golden Yimeng Group 23.4 148.4 4.0 1.34 Dongying Lufang Metallic Materials 22.5 104.3 3.9 1.37 Shandong Mining Machinery Group 20.5 62.0 3.5 1.58 Total for Batch 1 22.3 314.7 3.8 1.42 FIRR = Financial Internal Rates of Return; FNPV = Financial Net Present Value; DSCR = Debt Service Coverage Ratio; SPB = Simple Payback Period Source: Asian Development Bank estimates.

The financial viability of the three initial subprojects has been stress-tested under various adverse scenarios. As shown in Table 10, all three subprojects are found to remain stable and robust under various adverse scenarios in terms of FIRRs. Even under the unlikely combination of three adverse scenarios when the subprojects experience a cost overrun of 10%; drop of the facility capacity utilization rates drop by 10% below expectation; and a commissioning delay by 1 year, the calculated FIRRs would still be 10.5%, much higher than the calculated WACC of 3%.

Table 10: Sensitivity Analysis of Financial Performance Indicators Case Change FIRR (%) SI SV A. Base Case 22.3 B. Sensitivity Cases 1. Capital cost overrun 10% 19.9 1.7 60.0 2. Lower benefits 10% 13.9 5.8 17.1 3. Implementation delay 1 year 19.1 4. Combination of (i),(ii), and (iii) 10.5 FIRR = financial internal rate of return, SI = sensitivity indicator, SV = switching value. Notes: Sensitivity indicator is the ratio of percentage change in the FIRR divided by the percentage change in the given parameter. Switching value is the percentage change in a parameter for the project decision to change, that is, for the net present value to become zero or the FIRR to fall to the cut-off rate. Source: Asia Development Bank estimates.

Nevertheless, the DSCR can drop below 1.0 under exceptional adverse scenarios because of the short repayment period required by SPG. If such adverse events emerge, the subproject sponsors may request SPG/PMO to extend the loan tenure as there are ample rooms for extension. Furthermore, as discussed in Section 7.5.2, the assumed prices for the by-products sales (in the case of Golden Yimeng and Lufang subprojects) and service fees (in the case of SMM subproject) have been substantially biased to the low end to be conservative. The actual FIRRs are likely to be higher than that presented in Table 9 and Table 10.

30 Simple Payback Period (in Years) = Initial Investment for a Project/Resulting Annual Cash Flow

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7.3.3 Financial Performance of Financial Intermediary

A due diligence assessment was conducted on the selected FI, CEB; the findings of the due diligence assessment are provided in Appendix J. CEB is a national commercial bank established in 1992. In 2009, CEB was on the list of best 16 banks of Asia, and is also one of the top 10 banks of PRC. ADB was a shareholder and board member of CEB from 1996 to 2007 and during that period ADB introduced good corporate governance in the banking operation of CEB through providing technical assistance 31 and loan 32 that enhanced the capacity of CEB in prudent banking practices and successful introduction of international best practices to CEB, particularly in credit appraisal, post-disbursement loan management and corporate governance which no doubt benefited the CEB Jinan branch as well. The CEB Jinan branch, in Shandong, is a major onlending bank of loans from foreign governments and international financial institutions in Shandong province, and is familiar with the policies and procedures of SFB. Due diligence of CEB Jinan branch, indicates that it is financially sound, has adequate risk and management policies, acceptable corporate and financial management practices, and complies with regulatory requirements.

7.4 SOCIAL BENEFITS AND POVERTY REDUCTION

The Investment Program will not involve any new land acquisition or resettlement. The subject projects proposed by Lufang and Golden Yimeng would be constructed within the existing facilities and would not involve any land acquisition. SMM’s coal washing systems would be all located within the existing client sites (i.e. coal mines) and hence do not require land acquisition either. Any future subprojects that involve land acquisition or resettlement issues will not be considered under this Shandong EE&ER Project. Therefore, no land acquisition or resettlement plan is needed.

A summary of poverty reduction and social strategy is presented in Appendix O. As discussed in detail in Appendix O, the three subprojects would not result in workforce redundancy; rather they would create hundreds of new positions. Hence, the proposed project will not trigger any social safeguard policies.

The three initial subprojects are expected to create some 320 temporary job opportunities during the construction stage and 440 long-term jobs when in operation. As a result of the Project, the Shandong economy will gain CNY142.2 million at a discount rate of 12%, from income taxes. Laborers will gain CNY156.9 million because the subprojects pay wages in excess of the economic opportunity cost of labor. Consumers will gain CNY1,255.5 million because they can avail themselves of increased benefits at a lower cost than without the Project.

The share of the net economic benefits of the Project accruing to the poor is calculated to be 16.54% which is higher than the average poverty ratio 14.3% in the project areas. As such, the analysis concludes that the Project will support pro-poor economic growth. In fact, the share of 16.54% has not accounted for a number of other indirect benefits of the Project that are difficult to quantify. For example,

31 ADB. 1996. Technical assistance to the People’s Republic of China for Capacity Building of the Everbright Bank of China. Manila. 32 ADB. 1996. Report and Recommendation of the President to the Board of Directors: Proposed Loan to the People’s Republic of China for Everbright Bank of China. Manila.

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 The improvement in energy security and environmental quality under the Investment Program will benefit the poor more than the general population, as the poor are generally more vulnerable under adverse circumstances.;

 Golden Yimeng subproject will also provide 50,000 t/yr of quality organic fertilizers to local farmers, and help stimulate the local development of eco- farming; and

 The Project will reduce coal consumption, free up resources, and lower the risks associated with coal mining and transportation.

7.5 RISKS

7.5.1 Overall Project Risk

The risks associated with potential changes in Government policies and uncertain power demands in Shandong are minimal. The PRC recently reinforced its strong commitment to energy efficiency and emission reduction in its national program to address climate change issues including its objective to achieve 40%–45% carbon intensity improvement by 2020 compared with 2005. In June 2010, the State Council issued a new ESCO policy to provide a combination of energy saving rewards, tax breaks, and incentives to energy efficiency financing; provincial implementation details are expected to follow (other provinces have followed up) and top up the central government program. The macroeconomic conditions are expected to continue to be sound with continuing political stability in the PRC.

The subloan credit risks are minimized in various ways, including (i) requiring the posting of collateral and/or guarantees, (ii) checking credit and financial criteria when appraising applicants, (iii) accepting only subprojects with investment payback periods of less than 5 years to ensure adequate cash flow for subloan repayments, and (iv) requiring the subborrower to assume at least 25% of the total subproject investment cost. The FI will constantly monitor the repayments and make suitable interventions to recover the subloans, when required.

Under the proposed FIL scheme, a designated Shandong energy efficiency and emission reduction account will be set up by SFB at the financial intermediary bank to retain all the interest spread between of the relending rate from ADB to SFB and the onlending rate from FI to the subprojects. Up to 50% of the retained fund will be used for (a) PMO administration including funding for PMO expenses and staffing, (b) retaining independent implementation consultants to supplement the PMO’s shortage of expertise in ESMS; and (c) paying the financial intermediary bank’s management fees. (The other 50% will be used as reward to the sub-borrowers based on actual realized energy savings.) This will help ensure the sustainability of the PMO funding and the funding for retaining external expertise through the 15 years long tenure of this FIL. In addition to the above funding mechanism, the Shandong PMO is a joint World Bank/ADB project management office, which is currently implementing GEF Project ID 3743 and other World Bank projects with tenures as long as 30 years. This will help create a larger and more stable staffing pool to support the implementation of the Project.

Successful implementation the Project would require sound project and financial management. The Part B PPTA has been scheduled to help strengthen the project management and financial management of the PMO, FI and subborrowers.As

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Asian Development Bank 20/4/11 TA 7295 - PRC: Energy Efficiency and Emission Reduction Project in Shandong Province discussed previously, EE&ER subprojects inevitably share the market risk of the host facilities, the investment decision on an EE&ER subproject is often made on a balance of benefit and risk considerations beyond the EE&ER subproject itself. Under the market uncertainty, project owners may often be reluctant to act on the EE&ER initiatives despite the apparent good return on the investment, especially during market downturns (such as the 2008 global financial crisis). The selection of the initial subprojects in mid-stream industries in Shandong under this FIL is likely to help overcome this barrier because the mid-stream industries tend to have longer planning ranges. As well, as the selected subprojects are industrial leaders in Shandong and in the country, the success in the initial subprojects would provide SPG with the templates to help introduce sector-specific industrial policies that would help accelerate the technology alignments amongst similar facilities in the province. The policy induced needs for technology upgrades would in turn help generate additional potential subproject candidates.

In regards to risk associated with overall fund revolving, the initial subprojects are well prepared and have requested advanced procurement and retroactive financing, which will ensure timely implementation of the respective funds. Rollover risks are not anticipated because flexible redistribution of any unused ADB funds resulting from delayed disbursement can go on to finance the subsequent batches depending on their readiness. Beyond the first batch, the work scope of the Part B PPTA has been adjusted to include early identification of the second batch of subprojects. One key deliverable of the PPTA is to facilitate the buildup of a sufficient subproject pipeline. The experience gained by the PMO and financial intermediary through the first batch selection process is expected to enable implementation of timely and efficient selection procedures for subsequent batches.

7.5.2 Risk of Subprojects and Disbursement Conditions

All initial subprojects included in the first batch financing are based on proven and established technologies; and involve installation of energy efficiency equipment and appliances that have been used successfully in the PRC. In addition, most of the proposed retrofits can be implemented within a relatively short time (i.e., 1-2 years). For the subsequent batches, all subprojects will be required to use proven energy efficiency technologies with reliable, measurable, and verifiable energy and capacity savings. Third party measurement of actual energy savings of implemented subprojects will be carried out to verify the subprojects’ energy savings. Another element of technical risk often associated with energy intensive industries is production safety. As discussed below, initial subprojects are required to comply with the health and safety assurances forming part of the loan disbursement condition.

Market risks are inherent to manufacturing industries. Although the three initial subprojects pass sensitivity tests prior to subloan approval, the market fundamental may change rapidly during an economic crisis even within the short tenure of six years for the subloans. To help alleviate the financial risks associated the initial subprojects, the following conservatisms have been considered in the financial analysis presented in Appendix N:

 As indicated in Table 11, the assumed prices for the by-products sales (in the case of Golden Yimeng and Lufang subprojects) and service fees (in the case of SMM subproject) used in have been substantially biased toward the low end and are hence highly conservative;

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 In the case of Golden Yimeng subproject, sales of extra electricity to the grid are largely controlled by the grid company, which enjoys the monopoly and may not be offering a fair market price to purchase the extra electricity. To be on the safe side, the price of electricity sales is assumed to be only CNY 0.37/kWh, a steep discount from the local market price of CNY 0.55/kWh to CNY 0.66/kWh;

 The SMM ESCO involves financing of coal washing systems to achieve EE&ER at the client sites (i.e. coal mines). Unlike small ESCO projects, a coal washing system can cost over $10 million on average. While the market conditions in the foreseeable future would suggest a good return on the investment, the receivable risk is inherent as the equipments reside at the client sites and a substantial portion of the system is custom made. As such, a provision for equipment insurance up to 1% of the total equipment supply cost and a receivable reserve equivalent to 6% of the total investment has been considered in the financial analysis to help alleviate the potential risks; and

 Although the DSCR can drop below 1.0 under exceptional adverse scenarios because of the short repayment period required by SPG (net four years), the current aggressive repayment schedule also means that there is ample room for extension if a subproject runs into difficulty in repayment.

Table 11: Conservative Assumptions on the Prices of Subproject Outputs Used in the Financial Analysis

Output Assumed Current Market Subproject Output Unit Unit Price Unit Price CNY CNY Golden Yimeng Biogas Power Generation and Heat Supply Electricity (from methane boiler) MWh 372.4* 540 Heat (from methane boiler) GJ 30.0 51.6* Utilization of fermentation sludge as organic fertilizer Ton 750.0 Utilization of solar thermal energy Tsce 1,000.0 Utilization of anaerobic sludge as fuel Tsce 1,000.0 Upgrading organic aldehyde process Recovery electricity MWh 372.4* 550 - 560 Recovery of mid pressure saturated steam Ton 132.0 Recovery of low pressure superhot steam Ton 88.0 Recovery of softened water m3 5.0 Recovery of other energy Tsce 1,000.0 Upgrading acetate ester process Recovery of low pressure superhot stream Ton 88.0 Lufang Recovery of Sulfur Acid (100%) Ton 260.0* 500 Waste Heat Power Generation MWh 570.0*

Recovery of White Arsenic (As2O3) Ton 3,000.0* Waste Gypsum Residue Ton 23.4* Waste Heat Steam Production Ton 70.0* 140 SMM

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Coal Washing Service Charges Ton 6.8* 8.0 - 10.0 Note: *Unit price used in the subproject feasibility study reports. Sources: Subproject feasibility study reports and ADB estimates.

Without a subloan pre-approval, many industrial applicants may be reluctant to commit sufficient resources to prepare engineering details required for thorough technical assessment and to push through the often co-mingled and lengthy regulatory approval processes required for the EE&ER projects. The pressure for expedited appraisal, albeit necessary, may risk compromising the quality of necessary due diligence evaluation and regulatory approvals. In order to minimize such risk, innovative use of loan disbursement conditions may help strike a balance between the timeliness and thoroughness. Amongst the initial subprojects, such disbursement conditions would include:

 Golden Yimeng and Lufang Subprojects - disbursements of any cost components under the Golden Yimeng and Lufang subprojects are subject to acquisition of proper approvals on Environmental Impact Assessment (EIA), and Production Safety Impact pre-Assessment (SIA) from relevant authorities.

 Golden Yimeng Subproject – the use of biogas for power generation and heat supply may be achieved through a number of engineering alternatives with no immediately apparent winner at this point. Conceivably, a thorough steam and electricity balance and life-cycle cost-and-benefit analysis would be required to assess the proposal. However, this is not a small task that can be done without sufficient engineering detail, which the subproject sponsor is reluctant to undertake without pre-approval on the subproject in the first place. Hence, it is recommended that the subloan be approved with one of the disbursement conditions being completion of steam and electricity balance calculation and life-cycle cost-benefit analysis during the detailed design stage. The disbursement of any costs associated with the biogas boiler and power generation system would be subject to the receipt of a satisfactory analysis report by ADB that supports the final design. Further, a power supply agreement with the grid company would be needed for the Golden Yimeng subprojects to sell the generated power to the local grid.

 SMM Subproject - As the eventual coal washing sites under this subproject remain undecided during the PPTA, the actual coal washing plant projects have not been reviewed. Any coal washing system proposition with a total investment in excess of $15 million shall require ADB/PMO preview and pre- approval, as a condition for the disbursement under this ESCO subproject.

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8. POLICY RECOMMENDATIONS

8.1 RECOMMENDATIONS TO THE GOVERNMENT

As much as it remains a great challenge to attract sufficient investments into EE&ER projects, the EE&ER subsector has great market potential in Shandong. The Government has an active role to play in removing market distortions and lowering policy and financial barriers for industrial enterprises and investors in general to participate in EE&ER projects. A number of recommendations specifically relevant to this Investment Program are outlined below:

 Institutional Capacity Building: Much of the success of government policy initiatives and incentive programs, as well as the proposed interest rebate as the reward under this FIL, would reply on the professional resources available for EE&ER assessment, monitoring and verification. SGP has requested for ADB support for the proposed Shandong Energy Management Professional (EMP) certification program; and ADB has helped identify a grant to support the establishment of the program;

 Raising Awareness: A key to the success in recruiting subprojects in the subsequent batches of financing would be effective marketing of the FIL to potential candidates through seminars and workshops. It is recommended that a promotion component be built into the EMP program in order to raise the awareness of EE&ER opportunities beyond the current professional circles;

 Pilot Project Demonstration: All three subprojects contain substantial demonstrative technologies. Successful implementation of the current subprojects may greatly enhance Shandong’s relative competitiveness in the country in the respective industrial subsectors. As well, the success of the initial subprojects would provide SPG with the templates to help introduce sector- specific industrial policies that would help accelerate the technology alignments amongst similar facilities in the province. The policy induced needs for technology upgrades would in turn help generate additional potential project candidates for this Investment Program; and

 In June 2010, the State Council issued a new ESCO policy to provide a combination of energy saving rewards, tax breaks, and incentives to energy efficiency financing. A number of provinces have followed the lead of the central government and topped up with provincial performance-based rewards/incentives. For example, qualified ESCO companies in Guangdong Province will be able to receive incentive from Guangdong Energy Efficiency Fund at CNY80 for each tsce of energy saving in addition to the central government incentive of CNY220/tsce. It is recommended that SPG should set up a similar provincial fund to provide supplemental performance-based incentives for energy saving projects in Shandong in general and ESCO projects in particular.

8.2 RECOMMENDATIONS TO THE ADB

In the recent years, the Government of PRC has set up a variety of incentive programs based on energy saving performance. However, access to these national programs are not always conducive to small to medium sized industrial enterprises, especially private enterprises, because of the multiple-layer application requirements

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Asian Development Bank 20/4/11 TA 7295 - PRC: Energy Efficiency and Emission Reduction Project in Shandong Province from county/district, to municipality, the province, and eventually the central government. ADB can play a more active role under this FIL to encourage the growth of large ESCOs in Shandong with fast-track access to the existing national incentive programs. Further, ADB may encourage SPG to set up performance-based reward programs in Shandong for energy saving projects, which will in turn benefit the subprojects financed by this ADB FIL.

Without a subloan pre-approval, many industrial applicants may be reluctant to commit sufficient resources to prepare design details required for technical due diligence assessment and to push through the often co-mingled and lengthy regulatory approval processes required for major EE&ER projects. ADB may encourage innovative use of loan disbursement conditions by the PMO to help expedite the subloan approval process without compromising on the necessary due diligence evaluation and regulatory approvals. In particular, the PMO may be encouraged to grant subloan approvals to some highly desirable subprojects with the disbursement of a certain subproject component(s) tied to the satisfactory completion of technical due diligence on that project component. As such, the outstanding portion of the technical due diligence assessment, if any, can be completed in conjunction with the detailed design and in parallel of any outstanding regulatory approval processes, gaining the time and efficiency all around.

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Asian Development Bank 20/4/11

APPENDIX A: ENERGY SECTOR ANALYSIS

The People’s Republic of China (PRC) has the world’s second largest manufacturing sector and is the world’s largest exporter of goods. It has maintained average annual gross domestic product (GDP) growth in excess of 9% for the past quarter of a century, including an annual growth rate of 8.7% in 2009 during the global economic crisis.1 With an annual increase of carbon dioxide (CO2) emissions of more than 7% in the past 15 years, the PRC is now widely reported to be the second largest greenhouse gas emitter after the United States.2 However, the PRC, which had the highest energy intensity in 1980, has since experienced the strongest improvement in energy productivity3 of about 5% per year on average (7.5% per year from 1990 to 2000). As a result, the PRC's energy intensity is now slightly above the world average (it was 80% higher in 1990).4 In 2006, the PRC’s energy intensity per unit of GDP was about 20% higher than the Organization for Economic Co-operation and Development average5 and 2.37 times that of Japan.6 It currently remains about 40% above the average of Europe.

Shandong is the second largest PRC province in terms of industrial outputs. It comprises 17 municipalities and 139 counties, districts, and cities, spread over 156,700 km2 with a population of 94.17 million (2008). It borders Hebei Province to the north, and faces Bohai Bay and the Yellow Sea to the east. Its total GDP was CNY3.1 trillion in 2008, representing approximately 11% of the nation’s total GDP. Shandong's economy has grown consistently at a rapid rate, expanding at 12.5% per annum for the past 15 years (1995–2009)7, significantly higher than the national average. This economic growth momentum in Shandong is expected to continue in the foreseeable future putting even greater emphasis on accelerating investments in energy efficiency.

In the total GDP of CNY 3.1 trillion Yuan, 0.3 trillion Yuan was attributed to the primary industry, CNY1.77 trillion Yuan to the secondary industry and 1.04 trillion Yuan to the tertiary industry. The output value of heavy industry was over 65% of the total industrial output. This suggests that the economic development in Shandong Province is closely related to heavy industry

A. Energy Demands, Energy Efficiency and Emissions in Shandong

Energy Demand. In 2009, total energy consumption of Shandong Province was 314.0 million tons of standard coal equivalents (Mtsce)—10% of the national total of 285,000 Mtsce. The growth of energy demand in Shandong has been apace with the rapid expansion of the economy and expediting process of industrialization. The energy consumption in Shandong was approximately 68.9 Mtce in 2000 and increased to 215.9674 Mtce in 2008 with an average annual growth rate of approximately 13.5%. In fact, the energy demand was higher than the actual energy consumption. Approximately 75% of the generation capacity in the province is from coal-fired power plants. Between 2003 and 2008, Shandong experienced severe power

1 OECD. 2010, Economic Survey China 2010. Paris: OECD. 2 Ministry of Environmental Protection. 2009. State of Environment Reports. Beijing: Ministry of Environmental Protection. 3 Productivity reflects the nature of the economic activity, structure of the energy mix, climate, and technical energy efficiency (footnote 4). 4 World Energy Council. 2008. Energy Efficiency Policies around the World: Review and Evaluation. London: World Energy Council. 5 OECD. 2006. Environmental Performance Index, China. Paris: OECD. 6 World Bank. 2006. World Development Indicators 2006. Washington, D.C: World Bank. 7 Shandong Statistic Yearbooks (2009 and 2010)

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shortages during the summer peak periods, and had to curtail power supply to many industrial users.

Table A1: Total Final Energy Consumption and Composition in Shandong

Energy Consumption Energy Composition

(10,000 tce) Growth Rate (%) Coal (%) Crude Oil (%) Electricity (%) Others (%) Year

2000 6,885.48 1.04 31.23 24.03 17.86 26.88

2001 8,373.86 21.62 32.98 19.16 22.9 24.96

2002 8,255.16 (1.4) 37.81 18.99 18.31 24.89

2003 9,080.72 10.0 38.59 20.19 18.89 22.33

2004 10,934.46 20.4 33.40 24.7 19.04 22.86

2005 16,983.33 55.32 37.8 24.98 14.51 22.69

2006 18,632.68 9.71 37.4 23.56 15.25 23.78

2007 20,461.55 9.82 33.3 23.56 15.59 27.55

2008 21,596.74 5.55 36.8 20.05 15.52 27.62 ( ) = negative, tsce = ton of standard coal equivalent. Source: Shandong Statistics Year Book, 2009.

Approximately, 69% of the PRC's primary energy demand is met by coal;8 which was used to generate 83% of electricity in 2008. The primary energy demand in Shandong Province is met predominantly by coal (77% in 2009) and oil (21% in 2009). More than one-third of the total final energy consumption in the province was directly from coal (Table A1). As well, some 99% of generation capacity is from coal-fired power plants.

As a result of the combination of high energy consumption and heavy reliance on coal consumption, Shandong Province was the largest emitter of sulfur dioxide (SO2) of all the provinces, accounting for 7.5% of total SO2 emission in the country in 2008. The province’s annual SO2 emission annually ranged from 1.69 million tons to 2 million tons between 2000 to2008 (see Table A2). In addition, it was responsible for an estimated 10% of the national total nitrogen oxide (NOx) emissions and 8% of CO2 emissions. Over one-third of the province experienced acid rain in 2008, primarily as a result of SO2 and NOx pollution. Approximately, 48% of cities in the province fail to meet the nation al air quality standards. Emission reduction, hence, remains a huge challenge for the province, which cannot be met without substantial improvement of energy efficiency.

8 National Bureau of Statistics of China. 2008. China Statistical Yearbook, Total Energy Consumption and Its Composition. Beijing: National Bureau of Statistics of China.

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Table A2: Emissions of Major Pollutants in Shandong (2000-2008) (in 10,000 tons)

Year Sulfur Dioxide Soot

2000 180 67

2001 172 65

2002 169 62

2003 184 62

2004 182 52

2005 200 62

2006 196 58

2007 182 46

2008 169.2 Source: Shandong Statistics Year Book, 2009.

Energy Intensive Sectors: Structurally, energy consumption in Shandong Province is dominated by energy-intensive heavy industries, including power generation, petroleum and petrochemical, chemical, construction material (cement), coal, steel and iron, nonferrous metals, mechanical, textiles, and other manufacturing industries. As shown in Table A3, in 2008, secondary industrial consumers accounted for approximately 76.62% of total energy consumption; tertiary industry for approximately 12.68%; and primary industry and nonproduction consumption for the remaining 7.68%. The current industrial structure, as a result of historical development of the province’s economy, is unlikely to change in the foreseeable future.

Table A3: Shandong Province Sector Energy Consumption in 2008

Energy Consumption Total Sector (‘0000 tce) (%)

1. Primary Industry 863.8 3.02

Farming, Forestry, Animal Husbandry 863.8

2. Secondary Industry 21,931.2 76.62

Industry as Raw Materials and Fuels 21,368.2 74.66

Construction 563 1.97

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3. Tertiary Industry 3,628.8 12.68

Transport, Storage and Post 1,720.9 6.01

Wholesale, Retail Trade, Hotels and Catering Services 8,97.8 3.14

Others 1,010.2 3.53

4. Non-Production Consumption 2,197.8 7.68

Urban Areas 1,287.2 4.50

Rural Areas 910.6 3.18

Total 28,621.6 100.00 Source: Shandong Statistics Year Book, 2009.

Energy Efficiency: Despite Shandong’s achievements in improving energy efficiency in the recent years, its overall energy efficiency still has remained significantly lower than that of the most efficient economies in the China. Energy intensity in Shandong was 1.1 tce per CNY10,000 GDP in 2008 (1.175 tce in 2007) was not only higher than that of developed provinces such as Jiangsu, Zhejiang, Fujian, and Guangdong, etc, but also higher than the less developed provinces, such as Jiangxi and Anhui, ranking at 11th among the PRC provinces (see Table A4). Numerous industrial facilities in Shandong Province are old with low energy efficiency. Phasing out outdated production capacities has not been an easy task. For example, according to the unified national plan—in the Eleventh Five-Year Plan, 2006–2010—the province needs to shut down 4.3 gigawatts of small thermal power plants and eliminate outdated production capacity of 4.9 Mt of iron and 7.91 Mt of steel. But the existing requirement for phasing out energy inefficient equipment and technologies relies heavily on administrative measures, which have not been able to meet the target because of underfunded financial compensation and inadequate regulatory mechanisms.9

Table A4: Energy Efficiencies for Shandong and Other Provinces (2008)

Electricity Energy Consumption Energy Consumption per Unit Consumption per Unit per Unit GDP Industrial Value-added Region of GDP

(tce/10,000 yuan) (tce/10,000 yuan) (kw.h/10,000 yuan)

Beijing 0.662 1.037 719.61

Tianjin 0.947 1.053 910.42

Shanghai 0.801 0.958 884.13

Jiangsu 0.803 1.265 1149.44

9 Global Environment Facility. 2009. Thermal Power Efficiency Project. Washington, D.C: Global Environment Facility.

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Zhejiang 0.782 1.182 1202.08

Anhui 1.075 2.338 1106.81

Fujian 0.843 1.180 1098.56

Jiangxi 0.928 1.941 942.16

Shandong 1.10 1.698 1001.08

Guangdong 0.715 0.869 1085.49

Hainan 0.875 2.609 979.24 Source: Shandong Statistics Year Book, 2009.

B. Barriers to EE&ER Investments

The potential for energy efficiency and emission reduction in Shandong Province is huge, especially in energy-intensive industries. However, at least three key barriers may have impeded the development of the lending market for energy efficiency investments in general, and for medium-sized to large industrial energy efficiency investments in particular10:

(i) Medium-sized to large energy efficiency and emission reduction projects typically are technically more complex and require longer payback periods than small (and often relatively simple) energy efficiency projects. As well, larger energy conservation projects may tend to cause production interruptions during construction and/or installation;

(ii) The PRC commercial banks are asset-based lenders and lack of additional revenue generation by energy efficiency projects create difficulties for banks to assess cash-flow benefits and forgo collateral for significant lending; and

(iii) The risk perception among the domestic commercial banks has been compounded by their relative unfamiliarity with industrial energy conservation practices, as well as the market and technical complexity associated with some energy efficiency projects. The significant initial cost involved in developing the internal capacity for proper appraisal has resulted in a lack of institutional focus by domestic commercial banks.

Furthermore, in the currently underdeveloped energy service company (ESCO) market in the PRC, most ESCOs are small- to medium-sized enterprises with limited equity and collateral capacity, let alone technical and financing sophistication, to invest in medium-sized to large energy efficiency and emission reduction projects in midstream industries. The added

10 The size of an energy efficiency investment is defined by the estimated investment cost of a single energy efficiency technology intervention. The targeted energy efficiency investments of the proposed project range from $10 million and above, compared with small investments in the range of $1 million to $5 million or less. The size of an industrial enterprise is defined by its annual revenues. According to the China State Statistical Bureau (2008 Guidelines), enterprises are defined as medium-sized if their annual revenues are in the range of CNY30 million to CNY300 million (approximately $4.4 million to $40 million), and large if in excess of CNY300 million.

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complexity stems from the difficulty in measuring and verifying energy savings from complex industrial processes.

C. SPG Programs and Policies in Energy Efficiency

The PRC government recognizes the environmental challenges and climate change impacts of its growing energy use, and is aggressively addressing environmental issues and low energy efficiency in the economy with specific targets in the Eleventh five-year plan: (i) SO2 emission reduction of 10%, and (ii) energy efficiency improvements of 20% per unit of GDP. Furthermore, the government has formulated (i) the China Medium- and Long-Term Energy Conservation Plan,11 which has the goal of improving energy efficiency and resource utilization; and (ii) the Decision of the State Council on Enhancing Energy Conservation in 2006 (Guo Fa, No. 28) emphasizing energy conservation. The recently amended Energy Conservation Law became effective on 1 April 2008, and in November 2009 the government announced a plan to reduce carbon intensity of its GDP by 40%–45% by 2020 from the 2005 base level.

The SPG has placed high priority to promoting energy conservation and considers improvements in energy efficiency as an important pillar in its efforts to shaping a more environment/resource-conscious, sustainable economic growth path. The high concentration of energy-intensive heavy industries and relatively low energy efficiency require Shandong Province to reduce its energy intensity by 22% and SO2 emissions by 20% (from 2.0 Mt to 1.6 Mt) from 2006 to 2010—more aggressive targets than the national averages.

To meet these targets, the provincial party committee, together with the provincial government introduced Proposals on Further Strengthening the Work of Energy Saving and Emission Reduction (2007). The provincial government formulated The Comprehensive Plan of Implementation of Energy Saving and Emission Reduction in Shandong Province; implemented Plans and Methods for Energy Saving and Emission Statistics, Monitoring and Assessing; introduced energy-saving incentives and a price escalating system for excessive power consumption; and established organization and policy systems for guiding and promoting energy-saving work. In the first 3 years of the Eleventh Five-Year Plan, 2006–2010, Shandong Province's energy consumption per CNY10,000 GDP declined by 13.8% compared to a target of 22%. In 2009, its energy intensity 12 improved to 1.072 tsce per CNY10,000 of GDP 13 , representing a cumulative reduction of 18.5%.

Despite the improving energy intensity, it ranked at 19th amongst the 30 provinces in China. The underinvestment in energy efficiency and the existence of many energy-intensive industries in the province provide significant opportunities for further energy intensity reductions through targeted investment. The revised Energy Conservation Ordinance of Shandong Province took effect from November, 2009, which established a policy framework for energy efficiency improvement and pollutant reduction in Shandong, as outlined below:

 SPG will continue to enforce its policy to close serious, continuous polluters, allowing more energy efficient firms to develop and inefficient firms to fall. Further, the SPG’s economic strategy will focus on supporting those industries in moving up the value chain

11 National Development and Reform Commission. 2005. China Medium and Long Term Energy Conservation Plan. Beijing. 12 Energy intensity is a measure of the energy efficiency of a nation's economy. It is calculated as units of energy per unit of gross domestic product. 13 Source: Shandong Network, http://www.sdgb.cn/270675.aspx

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in order to help diversify the economy into high value-added, likely less polluting, sectors. One such effort is to retire small (typically less efficient with higher SO2 emission) thermal powers plants and incorporate a market-based SO2 cap-and-trade mechanism (footnote 8);

 Energy users shall abide by the state standards on energy conservation and the quota of energy consumption of both unit production value and unit product output set by the provincial energy conservation office and or SDRC. Key energy users shall regularly submit reports to corresponding statistics departments and energy conservation agencies on the status of energy utilization in accordance with the relevant state regulations;

 Energy efficiency of energy-using equipments like kilns, boilers, transformers, compressors, fans and pumps are required to comply with the relevant national and provincial energy conservation standards of the State and province. Energy users shall be required to upgrade or phase out the energy-using equipments that do not meet the relevant standards within certain deadlines;

 SPG shall encourage local financial institutions to support energy efficiency improvement and pollutant reduction projects;

 SPG will allocate energy conservation funds from both capital construction and technological restructuring investment funds to support rational energy utilization and development of renewable sources of energy;

 SPG shall encourage and support enterprises, science and research institutes to develop and popularize new energy saving technologies, techniques, materials and equipments. New products, which are included in plan of the State and the province, will enjoy preferential policies. The provincial government would encourage and support enterprises to adopt application of hi-technology in comprehensive energy utilization; and

 Promote public awareness through enhanced dissemination of information, knowledge and education on energy conservation.

A reference index of Shandong provincial energy policies and incentive programs is provided in Appendix B. These regulatory pressures, policies and incentive programs will create favorable investment environment and numerous project opportunities for the EE&ER sector in Shandong.

D. Energy Efficiency Investment Opportunities in Shandong

The consensus among Chinese experts is that most of the existing fixed assets in Shandong’s energy intensive industries, especially those in medium- and large-sized enterprises, will still remain in production until at least 2020. Hence, the majority of the energy saving potential would be attributable to retrofitting of energy intensive facilities at existing industrial and commercial establishments. There is thus a window of opportunity in the next five years to rehabilitate and upgrade these existing industrial assets to substantially improve their energy efficiency.

Further, the revised Energy Conservation Ordinance of Shandong Province (2009) requires targeted retiring of energy inefficient equipment and outdated production capacity. One of SPG’s latest efforts is to retire small (typically less efficient with higher SO2 emission) thermal

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powers plants and incorporate a market-based SO2 cap-and-trade mechanism (footnote 9), which will induce additional EE&ER investments in Shandong.

Despite SPG’s efforts in the recent years, there remains significant potential for energy efficiency improvement and green house gas (GHG) emission reduction as most of the concerned enterprises would rather invest in business expansion than energy conservation, although the Chinese experts agree that the majority of the identified industrial energy conservation investments are of high investment returns. The domestic banking sector has also been reluctant to step in to provide the required financing for the reason discussed in the previous section.

Part of the solution to the lack of investment desire in energy efficiency is to encourage the growth of ESCOs by private investors, manufacturers/distributors of energy efficiency equipments and/or vendors of energy efficiency technologies. ESCOs typically assist consumers by sharing the benefit of energy saving through energy performance contracts (EPC), wherein they finance the installation of energy efficiency equipments, implement energy efficient technologies and recover the investments from the savings in consumers’ electricity and fuel bills. This model has been adopted internationally; however, it runs into a number of persistent barriers in China, including low capitalization of ESCOs and lack of access to debt from domestic banks. The Government has long recognized the key role of ESCOs in meeting the energy efficiency and emission reduction project financing demands. Most recently, the State Council issued a circular outlining the national incentive programs, including provisions for ESCOs to access the central government budget currently designated to energy saving rewards and subsidies, a variety of pro-ESCO tax breaks and preferred accounting rules, encouragement to banks and other financial institutes to provide innovative financial instruments and to simplify loan applications and collateral requirements for ESCOs. 14

The small but developing ESCO industry in Shandong can expand into a full energy service industry with lowered barriers; and that has been identified by the SPG as a policy priority. Shandong was one of the three pilot provinces to set up one of the earliest ESCOs in the PRC in as early as 1998, called Shandong Rongshihua Leasing Co. (Rongshihua), with assistance from the World Bank - Global Environment Facility (GEF) (1998–2018). However, ESCO development in Shandong so far has primarily benefited small energy efficiency projects with an average investment of less than $1 million each,15 involving relatively simple technologies, such as upgrades of small boilers, pump and motor drives, lighting, air conditioners, and/or transformers. The potential ESCO financing opportunities for medium- to large-sized industrial energy efficiency and emission reduction projects remain largely untapped and hence warrant policy intervention.

14 Circular of the State Council, Development Reform Commission and other departments to speed up implementation of energy management contracts for the development of the energy service industry (Office of the State Council [2010, No. 25]). 15 A total of 86 projects with an average size of approximately $850,000 are set up under the World Bank financing program. (Source: a report to Shandong ADB PMO by Rongshihua).

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APPENDIX B: ENERGY SECTOR REGULATORY FRAMEWORK

A. Responsibilities of Energy Sector Institutions

The administrative framework overseeing energy in Shandong Province has been changing as China moves from a planned economy to a market economy. For example, environmental agencies did not have the authority to examine an energy project at the project’s inception in a planned-economy scheme; now they are empowered to do so. Shandong Provincial Economic and Information Technology Commission (SEITC), Shandong Development and Reform Commission (SDRC), Shandong Provincial Environmental Protection Bureau (SEPB), and Shandong Finance Bureau (SFB) are the key administrative organizations in the energy saving sector. In order to strengthen energy-saving management, the provincial government sets up a working group for energy-saving and emission reduction with the governor being the head and three vice governors as the deputy heads. The group’s office is located at SEITC. Municipalities also set up their own groups and offices in accordance with the provincial model.

SDRC is one of the provincial government departments in charge of the whole provincial economic plans. Concerning energy project, the functions of SDRC can be summarized as follows:

 Designing and implementing the policy of provincial energy and promoting high-efficiency, low polluting and energy saving projects (which are carried out jointly with SEITC and PEPB);

 Developing policies to assess and examine the feasibility of an energy project at the start- up phase, which is based on the national energy policy. Without the endorsement from SDRC, such projects cannot proceed to the next stage;

 In charge of assessing, examining and approving the feasibility studies of energy saving projects; and

 Making energy price policies and setting up or abolishing items of fee-collection for energy services.

SEITC is a department responsible for state-owned enterprises in the energy sector. The Shandong Provincial Energy Conservation Office (SECC) is an office under SEITC; its responsibilities can be summarized as follows:

 Planning for the whole provincial energy saving; establishing rules, norms, and technical standards, proposing policies on energy saving authorized by the provincial government;

 Prompting the development of energy-saving industries, establishing design standards and technical criteria concerning energy saving engineering and operation management;

 Guiding the energy saving agencies at the provincial and local city levels to monitor and administrate the local energy saving market, and supervise the administration of the energy saving sector in the province; and

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 Providing the primary review of energy saving projects; and conduct planning for energy saving. Each city had energy saving offices at the city level.

SEPB oversees and supervises the environmental performance of local enterprises including energy projects, and is responsible for penalizing polluting enterprises under environmental protection laws and regulations. As part of local government, the SEPB is becoming an increasingly important agency, which plays a significant role in boosting energy saving by taking charge of assessing the environmental impact on energy projects at their inception and then making decision to approve or oppose it.

SFB is responsible for the income and expenditures of the provincial government. SFB’s responsibilities in the power sector are to establish and manage the financial system for power firms, establish tax policies in the energy sector, and protect the value of state-owned assets.

B. Reference Index of Shandong Provincial EE&ER Policies and Incentives

1. The Government of Shandong Province’s Notification of Approving the Approaches of Statistical Monitoring the Energy-saving and Emission Reduction and Assessing the Implementation Plan (The Government of Shandong Province〔2008〕NO.55)

2. The Government of Shandong Province’s Notification of Further Strengthening the Implementation Plan of Fuel Saving and Electricity Saving (The Government of Shandong Province〔2008〕NO.83)

3. The Office of the Government of Shandong Province’s Notification of Well Conducting the Energy-saving Evaluation and Audit for the Fixed Assets Investment Projects (The Office of the Government of Shandong Province〔2007〕NO.42)

4. The Office of the Government of Shandong Province’s Notification of Further Strictly Controlling the Fixed Assets Investment Projects in High Energy-Consuming Industries (The Office of the Government of Shandong Province〔2007〕NO.59)

5. Forwarded Notification of the Office of the Government of Shandong Province of the Comments from the Provincial Energy-saving Office on Facilitating the Development of Energy-saving Industry (The Office of the Government of Shandong Province〔2008〕 NO.63)

6. Forwarded Notification of the Office of the Government of Shandong Province of the Comments from the Provincial Bureau of Finance on the Governmental Procurement of Energy-saving Products (The Office of the Government of Shandong Province〔2008〕 NO.74)

7. The Office of the Government of Shandong Province’s Urgent Notification of Strengthening the Management of the Electricity Demand Side and Utilizing the Electricity Appropriately (The Office of the Government of Shandong Province〔2008〕NO.30)

8. The Office of the Government of Shandong Province’s Notification of the Comments on Strengthening the Management of the Electricity Demand Side, Saving Electricity, and

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Utilizing the Electricity Appropriately (The Office of the Government of Shandong Province 〔2008〕NO.111)

9. The Office of the Government of Shandong Province’s Notification of Supporting the development of Significant Enterprises in Semiconductor Lighting Industry (The Office of the Government of Shandong Province〔2008〕NO.9)

10. The Government of Shandong Province’s Bulletin of Honoring the awarded Energy-saving Enterprises and Accomplishment of Shandong Province (The Government of Shandong Province〔2008〕NO.140)

11. Shandong Economic and Trade Committee’s Notification of Energy-saving and Emission Reduction Training for 1000 Significant Energy-consuming Enterprises (the first term)(Shandong Economic & Trade Committee〔2008〕NO.87)

12. Shandong Economic and Trade Committee’s Notification of Energy-saving and Emission Reduction Workshop (Shandong Economic & Trade Committee〔2008〕NO.159)

13. Shandong Economic and Trade Committee’s Notification of the Inspection of the Financial Incentive Program for the Solar Thermal System in 2007(Shandong Economic & Trade Committee〔2008〕NO.170)

14. Shandong Economic and Trade Committee’s Forwarded Notification of National Development & Reform Commission of Training the Significant Energy-consuming Enterprises on How to Report the Energy Usage (Shandong Economic & Trade Committee 〔2008〕NO.178)

15. Shandong Economic and Trade Committee’s Forwarded Notification, National Development & Reform Commission’s Notification of the Implementation Plan of the Energy Utilization Reporting System of the Significant Energy-consuming Enterprises (Shandong Economic & Trade Committee〔2008〕NO.224)

16. Shandong Economic and Trade Committee’s Reply of Building China(Shandong) Energy- saving and Environmental Protection Industrial Park in the City of Tai’an (Shandong Economic & Trade Committee〔2008〕NO.283)

17. Shandong Economic and Trade Committee’s Report of the Final Evaluation of the Energy- saving Goal Achieving of 103 National Energy-consuming Enterprises in Shandong Province in 2007(Shandong Economic & Trade Committee〔2008〕NO.135)

18. Shandong Economic and Trade Committee’s Report of the Implementation Plan of Promoting the first Financial Incentives for high-efficiency Lighting Products (Shandong Economic & Trade Committee〔2008〕NO.265)

19. Shandong Economic and Trade Committee’s Notification of the Financial Incentive Program Plan for the Solar Thermal System in 2008(Shandong Economic & Trade Committee〔2008〕NO.295)

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20. Shandong Economic and Trade Committee’s Notification of Printing and Distributing Implementation Plan of Promoting the High-efficiency Lighting Products in Shandong Province (Shandong Economic & Trade Committee〔2008〕NO.300)

21. Shandong Economic and Trade Committee’s Notification of Printing and Distributing the Tentative Methods for Energy Audit in Shandong Province (Shandong Economic & Trade Committee〔2008〕NO.361)

22. Shandong Economic and Trade Committee’s Notification of the Demonstration of Establishing the Energy Management System in Enterprises (Shandong Economic & Trade Committee〔2008〕NO.363)

23. Shandong Economic and Trade Committee’s Notification of Issuing the Energy-saving Monitoring Plan in 2008(Shandong Economic & Trade Committee〔2008〕NO.400)

24. Shandong Economic and Trade Committee’s Notification of the Program Plan of Financial Incentive for Solar Thermal System in Shandong Province in 2007(Shandong Economic & Trade Committee〔2008〕NO.445)

25. Shandong Economic and Trade Committee’s Notification of the Checklist of the to be Applied Energy-saving and Emission Reduction Electronic Information Technology in Industrial Field, the Recommended Energy-saving Mechanical and Electrical Equipment, and the Dismissed out-dated M&E Equipments (Shandong Economic & Trade Committee 〔2008〕NO.515)

26. Shandong Economic and Trade Committee’s Notification of the Plan for Significant Energy- saving Projects in 2008(Shandong Economic & Trade Committee〔2008〕NO.516)

27. Shandong Economic and Trade Committee’s Approval of the Financial Incentive Program for the Solar Thermal System in 2007 and 2008(Shandong Economic & Trade Committee 〔2008〕NO.539)

28. Shandong Economic and Trade Committee’s Notification of the three types of “100 Energy- saving Projects”(the second group projects)(Shandong Economic & Trade Committee 〔2008〕NO.586)

29. Shandong Economic and Trade Committee’s Report of the Final Evaluation of the Energy- saving Goal Achieving of 103 National Energy-consuming Enterprises in Shandong Province in 2008(Shandong Economic & Trade Committee〔2009〕NO.114)

30. Shandong Economic and Trade Committee’s Notification of the Announcement of the Checklist of the Cleaner Production Advisory Service Organization in Shandong Province (the third group)(Shandong Economic & Trade Committee〔2008〕NO.366)

31. Shandong Economic and Trade Committee’s Notification of the Announcement of the Companies which Applying Cleaner Production Technologies in Shandong Province (Shandong Economic & Trade Committee〔2008〕NO.426)

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32. Shandong Economic and Trade Committee’s Notification of Printing and Distributing the Tentative Methods of the Energy-saving Evaluation for Enterprises’ Technology Retrofitting in Shandong Province (Shandong Economic & Trade Committee〔2007〕NO.236)

33. Shandong Economic and Trade Committee’s Notification of Printing and Distributing the Key Working Points of Energy-saving and Consumption Reduction in Shandong Province in 2008(Shandong Economic & Trade Committee〔2008〕NO.24)

34. Notification of Shandong Economic and Trade Committee and the other 16 Departments of Organizing the Activity of the Energy-saving Awareness Week in 2008 (Shandong Economic & Trade Committee〔2008〕NO. 234)

35. Notification of Shandong Energy-saving and Emission Reduction Leading Group of Printing and Distributing the Primary Breakdown Working Plan on Carrying out the Shandong Government’s Comments on Further Strengthening Energy-saving and Emission Reduction (Shandong Energy-saving and Emission Reduction Leading Group〔2008〕NO.2)

36. The Office of Shandong Energy-saving and Emission Reduction’s Notification of Printing and Distributing the Goal Estimation Table of the Energy Consumption Reduction per Each Ten Thousand CNY GDP during the three years after the 11th Five-Year Plan for Each City of Shandong Province (The Office of Shandong Energy-saving and Emission Reduction 〔2008〕NO.6)

37. Notification of the Shandong Office of Energy-saving and Shandong Economic and Trade Committee of Printing and Distributing Key Working Points of the Energy-saving of Shandong Province in 2009(Shandong Office of Energy-saving〔2008〕NO.573)

38. Notification of Shandong Energy-saving Supervision Team of Printing and Distributing the Implementation Plan of Energy-saving Supervision in Shandong Province in 2008(Shandong Energy-saving Supervision Team〔2008〕NO.1)

39. Notification of Shandong Energy-saving Supervision Team of Supervising the Primary Energy-consuming Equipments in Major Energy-consuming Companies (Shandong Energy-saving Supervision Team〔2008〕NO.5)

40. Notification of Shandong Energy-saving Supervision Team of Further Well Conducting the First Provincial Energy-saving Supervision (Shandong Energy-saving Supervision Team 〔2008〕NO.11)

41. Comments of the Government of Shandong Province on Further Strengthening the Energy- Saving and Emission Reduction (The Government of Shandong Province [2007]NO.24)

42. The Government of Shandong Province’s Notification of Printing and Distributing the Comprehensive Implementation Scheme of the Energy-saving and Emission Reduction (The Government of Shandong Province[2007]NO.39)

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43. Notification of Printing and Distributing the Sector Division of Comprehensive Implementation Scheme of the Energy-saving and Emission Reduction in Shandong Province (Shandong Energy-saving and Emission Reduction Leading Group [2007]NO.1)

44. Comments of the Government of Shandong Province on Strengthening the Seawater Utilization (The Government of Shandong Province〔2007〕NO.32)

45. Management of Fare Increasing for the Exceed-standard Energy Consumption in Shandong Province (Tentative) (The Office of the Government of Shandong Province[2007]NO.10)

46. The Office of the Government of Shandong Province’s Notification of Well Conducting the Energy-saving Evaluation and Audit for the Fixed Assets Investment Projects (The Office of the Government of Shandong Province [2007] NO.42)

47. The Office of the Government of Shandong Province Carries out State Council General Office〔2007〕NO.42 Document, Notification of Strictly Implementing the Standard of the Air-conditioning Temperature Control in Public Buildings (The Office of the Government of Shandong Province〔2007〕NO.47)

48. The Office of the Government of Shandong Province’s Notification of Further Strictly Controlling the Fixed Assets Investment Projects in High Energy-Consuming Industries (The Office of the Government of Shandong Province[2007]NO.59)

49. The Office of the Government of Shandong Province’s Urgent Notification of Examining the High Energy-Consuming and High Polluting Industries (The Office of the Government of Shandong Province〔2007〕NO.80)

50. The Office of the Government of Shandong Province’s Notification of Carefully Studying and Carrying out the Spirit of the 17th Congress of Communist Party of China to Conduct Well the On-going Works (The Office of the Government of Shandong Province[2007]NO.160)

51. The Office of the Government of Shandong Province’s Notification of the Inspection of Energy-saving and Emission Reduction throughout Shandong Province (The Office of the Government of Shandong Province[2007]NO.177)

52. The Office of the Government of Shandong Province’s Notification of Establishing the Leading Panel of the Energy-saving and Emission Reduction in Shandong Province (The Office of the Government of Shandong Province[2007]NO.95)

53. The Government of Shandong Province’s Notification of the Assessment of the Energy- saving Goal in 2006(The Government of Shandong Province [2007]NO.159)

54. Notification of the Government of Shandong Province of Honoring the awarded Energy- saving Enterprises and Accomplishment of Shandong Province in 2006(The Government of Shandong Province [2007]NO.166)

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55. Notification of Organizing and implementing the 100 Energy-saving Projects the first 100 projects)(Shandong Economic & Trade Committee[2007] NO.91)

56. Notification of Organizing the Energy-saving Inspection throughout Shandong Province in 2007(Shandong Economic & Trade Committee〔2007〕NO.108)

57. Notification of Well Recommending the Energy Audit Organization Shandong Economic & Trade Committee [2007] NO.289)

58. Forwarded Notification of National Development & Reform Commission of Printing and Distributing the Implementation Plan of the Energy-efficiency Goal for Primary Energy- consuming Enterprises Shandong Economic & Trade Committee〔2007〕NO.293)

59. Notification of Recommending the Energy Audit Organization (the first group) (Shandong Economic & Trade Committee [2007] NO.422)

60. Notification of Printing and Distributing the Tentative Approaches of Energy-saving Evaluation for the Technology Retrofitting of Enterprises in Shandong (Shandong Economic & Trade Committee [2007] NO.236)

61. Notification of Printing and Distributing the Implementation Plan of “Public Action on Energy-saving and Emission Reduction in Shandong Province”(Shandong Economic & Trade Committee [2007] NO.362)

62. Notification of Well Recommending the Application of Energy-saving Award of Shandong Province (Shandong Energy-saving Office [2007] NO.1)

63. Notification of Shandong Energy-saving Office of Printing and Distributing the Key Working Points of Building Conservative Society in Shandong Province in 2007(Shandong Energy- saving Office [2007]NO.2)

64. Notification of Further Carrying out the Work of Energy-saving and Consumption Reduction (Shandong Energy-saving Office [2007] NO.2)

65. Notification of Shandong Energy-saving Office of Printing and Distributing the Working Plan of Examining High Energy-Consuming and High Polluting Industries in Shandong Province (Shandong Energy-saving Office〔2007〕NO.3)

66. Notification of the Promotion of Energy-saving Lamps (Shandong Energy-saving Office [2007] NO.4)

67. Notification of Shandong Energy-saving Office of Printing and Distributing the Social Communication Working Plan of Building Conservative Society in Shandong Province in 2007(Shandong Energy-saving Office [2007] NO.5)

68. Notification of Reporting the Primary Standards of Energy-saving and Emission Reduction (Shandong Energy-saving Office [2007] NO.6)

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69. Approval of Establishing the Provincial Energy-saving Supervision Team (Shandong Organizational Establishment Committee Office [2007] NO.34)

70. Forwarded Notification of the Office of National Development & Reform Commission of Distributing the Guideline of Verification of Energy Auditing and Energy-Saving Planning(2007-01-05)

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APPENDIX C: EXTERNAL ASSISTANCE AND LESSONS

A. External Assistance

By 2008, ADB’s energy sector lending to the PRC exceeded $4.0 billion for 30 loans, which had successfully facilitated the introduction and expansion of higher-risk new technologies and new mechanisms, such as combined heat and power plants, coal mine methane (CMM) and coal-bed methane (CBM) extraction, pumped storage power plants, emission trading mechanisms, 500 kilovolt transmission lines, gas insulated substations, as well as documentation and transaction for CDM projects. Non-lending support of about $50 million has evolved from tariff reforms, sector restructuring, establishment of the electricity regulator, and mainstreaming environment evaluation, to innovative technologies and mechanisms in energy efficiency and renewable energy, and to capacity building for CDM.

ADB assistance, in the form of policy advice, knowledge services, TA, project financing, and risk mitigation services, will focus on (i) energy efficiency and energy conservation; (ii) renewable energy, mainly wind, biomass, and hydropower; (iii) clean coal technologies; (iv) urban environment improvement; (v) CMM and CBM; and (vi) regional cooperation in power. ADB will also support the Government in intensifying sector reforms and building capacity (particularly at the provincial and project implementation level), nurturing a more efficient energy market by catalyzing private investment, mobilizing the participation of domestic financial institutions, stimulating CDM-related carbon trading, assisting local energy service companies, and removing major barriers to the transfer and adoption of low-carbon technologies.

In these focal areas, ADB will continue to conceptualize innovative projects and use new initiatives and flexible financing tools, e.g., the Carbon Market Initiative (CMI), the Clean Energy Financing Partnership Facility, the Energy Efficiency Initiative (EEI), financial intermediation, and multi-tranche financing facilities, in planning, designing, and implementing projects with tangible demonstration effects and significant opportunities for replication. Sector interventions will be closely coordinated with private sector operations, and will actively seek private or non-sovereign investment. Some projects targeted for the poor western provinces will directly benefit local rural communities, thereby promoting inclusive growth. ADB assistance will improve sector governance by adopting international best practices, ensuring efficient and fair procurement, mainstreaming participatory project design, and enhancing compliance with safeguards.

Many different approaches are needed to fully tap various segments with significant energy efficiency potentials in the PRC. ADB has developed several projects under EEI. In its public sector operations, ADB is working with provincial government to

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provide a financial intermediation loan to a provincial trust company to finance energy efficiency in the industrial sector. In the private sector, in addition to the proposed Program, ADB has called for proposals from private equity funds interested in equity investment in clean energy and energy efficiency projects.

The World Bank (WB) is another source of external funding for the PRC’s power subsector. Since the early 1990s, it has provided more than $6.2 billion to finance 25 projects, most of which are large-scale thermal and hydropower projects, and power transmission and distribution projects. In the recent years, the World Bank provided loans to support the Government’s urban environment improvement and development of renewable energy. Its projects also have a strong focus on environment energy efficiency and use of renewable energy. One notable project approved in 1998 supported three pilot companies in Beijing, Liaoning, and Shandong, which were among the first energy service companies (ESCOs) in the PRC.1 The World Bank also provided TAs for power subsector restructuring and heating subsector reforms. In the interest of addressing finance-related barriers for implementing energy efficiency projects, the World Bank together with other organizations implemented a study covering Brazil, PRC, and India to establish banking windows, explore guarantee mechanisms, support ESCOs, and attract equity investment in energy efficiency projects. The World Bank is currently preparing a typical financial intermediation loan (FIL) in partnership with domestic banks for approval by June 2008, which will include capacity building support from the Global Environment Facility. Another FIL in the private sector will extend guarantees to loans extended by domestic partner banks to utility companies that help gas and district heating consumers reduce energy demand.

ADB has established a working relationship with the World Bank in addressing policy issues and coordinating lending and TA operations; and exchanges views with bilateral sources and the private sector. Both ADB and the World Bank emphasize the importance of promoting energy efficiency projects, increasing provincial government involvement in clean energy projects, developing ESCOs and local banks to play a bigger role in clean energy financing, and environmental protection. Annual aid coordination meetings are held in Beijing to share strategies; ADB hosted the 2007 meeting in its PRC Resident Mission in April 2007.

The United Nations Development Programme is providing assistance for studies regarding options for power sector restructuring and promotion of energy conservation. The ongoing China End-Use Energy Efficiency Project aims to promote energy efficiency in major energy-consuming sectors such as industries and building constructions.

1 The World Bank, 1998 Energy Conservation Project. Washington, DC.

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European Investment Bank (EIB) is c urrently in its first phase of providing China Climate Change Framework Loan (CCCFL) under the EU-China Partnership on Climate Change that was launched during the EU-China Summit in 2005 and encompasses the China-EU Action Plan on Energy Efficiency and Renewable Energies and the China-EU Action Plan on Clean Coal. The first phase of CCCFL includes up to 14 projects with a total loan amount of 220 million Euros. For the second phase of the CCCFL, more than 500 million Euros is being considered. The projects financed under the first phase range from renewable energy, to forestation, and to energy efficiency, and include projects in Shandong Province. Among bilateral sources, the Japan Bank for International Cooperation is the largest source of external assistance for the PRC’s power subsector. It has provided concessional loans totaling CNY 438 billion for 14 power projects through its official development assistance window. It has also provided special credits to major cities to improve their environment by installing emission control devices and equipment in power plants and factories, and by building water treatment facilities. It is considering shifting its traditional focus of assistance in the power subsector from hydropower and thermal power generation to energy conservation and renewable energy, particularly in the western region. German development cooperation, through Kreditanstalt für Wiederaufbau (KfW), has approved approximately $400 million in mixed credits, mostly for power plants and turbine modernization projects. KfW has also supported the Government in energy efficiency and renewable energy development. Other bilateral sources providing export credits or mixed credits in the energy sector include Australia, Canada, Denmark, France, Italy, Spain, United Kingdom, and United States.

Listed in Table C1 are the major development partners in energy efficiency and emission reduction in Shandong Province.

Table C1: Major Development Partners Amount Development Partner Project Name Duration ($ million) District Heating CCCFL District Heating Energy Efficiency. 2009 31 loans (Ongoing) (total European Investment Bank The project finances transformation and investment is upgrading of the heating network, automation €53 million) of operational system, and installation of motor variable frequency control systems.

Rushihua Energy Service The PRC’s energy conservation industry 1998–2018 $151 million Company began with three energy service companies created in 1998 in Beijing, Liaoning, and World Bank Shandong through the China Energy Conservation Project, which is backed by the

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Government of the PRC, World Bank, GEF, and the European Commission. For Shandong, the European Commission provided a grant of €1 million, GEF provided a grant of $5 million, and the World Bank provided a loan of $21 million.

Thermal Power Plant China Thermal Power Efficiency Project 2009 Grant of Efficiency (Shanxi and Shandong)—GEF grant (Ongoing) $19.7 The project development objective is to (Will come World Bank, GEF reduce coal consumption and greenhouse with $200 gas emission per unit of electricity production million loan) in the PRC provinces of Guangdong, Shandong, and Shanxi.

Energy Efficiency Scale-Up Provincial Energy Efficiency Scale-Up 2010 GEF grant Program, Shandong, Shanxi, and Jiangxi (Ongoing) 13.6 million International Bank for (GEF Project ID 3743) (total loan is Reconstruction and $327.4 Development, World Bank million)

Energy (power plant) World Bank China: Shandong Flue Gas 2008–2012 $50.00 million Desulfurization Project loan World Bank The objective of the Shandong Power Plant Flue Gas Desulfurization Project for the PRC is to reduce sulfur dioxide emissions in the heat and power subsectors and enhance the capacity of regulatory authorities to monitor and enforce compliance with their sulfur dioxide emissions reduction program.

CCCFL = China Climate Change Framework loan, GEF = Global Environment Facility, PRC = People’s Republic of China. Source: Asian Development Bank.

Clean Development Mechanism (CDM): Comparing with developed countries, China has lower emission reduction cost. From an international point of view, the provisions of the Framework Convention indicate that the cost is more than 30 U.S. dollars per ton CO2e, while China’s cost is roughly at 15 U.S. dollars per ton CO2e. Coupled with China’s energy demand growth, increased projects in line with conditions of emission reduction, and large scale of economy, these advantages are conducive to international carbon emission trade, and will attract international capital into the emission reduction projects. In 2006, the global carbon trade and CDM carbon trading

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market reach a scale of 30 billion U.S. dollars. At present, more than 50 financial institutions worldwide have joined the global climate change investment networks, and the investment has reached 13 trillion dollars. By February 2008 , the certified emission reduction credits gained b y Chinese CDM projects from the United Nations CDM Executive Board reached 36.37 million tons, accounting for 31.33% of the total CERs that the UN had approved, surpassing India for the first time as the largest CDM carbon trading volume country.

B. Lessons

ADB’s overall experience with energy sector projects in the PRC has been positive. Projects are generally well designed and smoothly implemented, although front-end delays have occurred in some projects. Success is attributed to extensive preparation prior to ADB intervention, high sense of local ownership, effective leadership in project management offices, and timely policy and enterprise reforms. The front-end delays in loan signing and loan effectiveness did not lead to unsatisfactory performance. The Government has implemented reforms on investment regulations, which simplify approval procedures and delegate some approving authority to the provincial governments. ADB has been working closely with the Government to harmonize the two approval procedures to minimize project start-up and implementation delays.

Project completion and performance audit reports for ADB-financed projects in the PRC highlight the (i) need to improve financial reporting, (ii) need for more attention to environmental matters, (iii) advisability of using larger boiler-turbine units, and (iv) necessity for capacity building, not only for project preparation, but also for staff training in operations and management aspects. The overall implementation performance of the energy portfolio is satisfactory. The performance ratings are given in Table C2.

Table C2: Post Evaluation Performance Rating of Energy Projects

Performance Loan Project Title Rating 880 Fuel Conversion Project Successful Second Industrial Energy Efficiency and Environment 1436 Successful Improvement Project 1318 Hunan Lingjintan Hydropower Project Successful Source: Asian Development Bank.

The World Bank review of experience in energy efficiency has shown that projects should seek to test a variety of business models to achieve energy savings. In particular, access to appropriate project financing that supports ESCO transactions should be an integral aspect of project design. It also suggests that procurement and

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disbursement procedures should be simplified as these increase transaction costs and discourage energy efficiency.2

International financial institutes (IFI), such as the ADB, the World Bank/GEF and EIB have been very active in Shandong in the recent years with remarkable achievements in the areas of agricultural, infrastructural, public utility and environmental developments as well as renewable energy, energy efficiency and emission reduction. However, the relative abundance of domestic capital in the recent years has helped lowered the desire for IFI financing. In comparison with domestic loans, the IFI loan appraisal process has been perceived to be burdened with multiple layers of management oversight, which tend to increase the turnaround time of loan appraisal. The issue may not be as critical for the IFI financing in conventional infrastructural and environmental projects in the public sector but it appears to amplify when appraising energy efficiency projects that involve industries and private enterprises as they are constantly under the high demand of the fast evolving market.

In 2007, ADB introduced an innovative mechanism to promote energy efficiency projects packaged as an “efficiency power plant (EPP)” in its Guangdong Energy Efficiency and Environmental Improvement Investment Program. It is a multi-tranche financial intermediation loan (FIL) with the first tranche loan of $35 million and subsequent tranches up to $65 million. Each new tranche needs to submit new PFR for ADB approval. Subsequent on-lending would require no further approval from ADB with the exception of ADB review on the sub-loans greater than $10 million. Financial intermediary functions are primarily with the selected financial intermediary trust company (GFTC). Financial intermediary management fee was paid by GPG contribution.

The design of this proposed revolving FIL, once set up, is intended to be another pilot attempting to streamline the subproject appraisal and loan management by (i) thoroughly reviewing project readiness on key factors that may potentially delay the start-up, including regulatory approvals of feasibility study reports and EIA reports, (ii) providing conservative estimates of the expected energy savings to help minimize the market risks; (ii) introducing competitive process for selection of the financial intermediary for the loan management, (v) setting up project implementing units with autonomy for operations and procurement decisions, (vi) allowing more flexible business models for setting up ESCO subprojects, and (vii) focusing initial subprojects on mid-stream industries with key role in the local industrial value chain, which has helped motivate the local governments to provide the necessary guaranties required for the subloans.

2 The World Bank. 2004. World Bank Global Environment Facility Energy Efficiency Portfolio Review and Practitioners' Handbook. Washington, DC.

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Historically, IFI loans in China have been primarily directed towards public sector and state-owned enterprises. This may be, in part, attributable to the state guaranty required for the conventional IFI loans. However, an unexpected “side effect” of the government’s guaranty on IFI loans is that the enterprises may become less active in repayment, increasing the risk on loan repayment. All three initial subprojects under this Shandong FIL are private-owned enterprises, which are guaranteed by the motivated governments: by focusing the initial subprojects on mid-stream industries with key roles in the local industrial value chain, the local governments have been motivated to arrange for the necessary guaranties required for the subloans.

ESCOs can be developed to capture the small-scale segment of the energy efficiency market, typically overlooked by financial institutions. The World Bank and ADB have been actively supporting and financing ESCO pilot projects in China, including the Ronshihua ESCO pilot project in Shandong, funded by the World Bank/GEF. However, ESCO is not necessary a versatile solution to a wide spectrum of often complex industrial EE&ER opportunities as it requires a number of inherent attributes for the candidate projects to succeed. For example, the three-country studies—Brazil, PRC, and India—by the World Bank and United Nations Environment Programme, have identified that, among other things, an essential attribute of the candidate projects to be considered for ESCO is that the energy saving amount has to be easy to measure and verify. With the exception of some select niches, industrial EE&ER projects in general can be complex; and it may be difficult to establish a proper baseline for an EE&ER project component inside a large industrial complex and often subject to deputes. One of the initial subprojects in this FIL program is a technology/equipment oriented ESCO specializing in coal washing, which is primarily paid based on the simple tonnage of raw coal processed.

During the project implementation stage, there would appeared to be three principal causes for operational failures for energy efficiency project financing, including (a) ineffective local institutional delivery mechanisms; (b) inadequate attention towards building technical capacity for monitoring and verification of energy savings and emission reduction; and (c) lack of sustained effort and follow-through in response to market changes through the duration of project implementation. To address these issues would create a constant high demand on the EA staffing resources and/or consultant inputs throughout the project life cycle.

A comparison between the ongoing Guangdong EPP and the proposed Shandong Energy Efficiency and Emission Reduction Project is provided in Appendix C1. As indicated in Appendix C1, the PMO staff positions of the Guangdong EPP Project are directly funded by Guangdong Province, which is supported by qualified independent consultants funded by an ADB grant for EE&ER monitoring/verification.

Under the proposed FIL scheme in Shandong, a designated Shandong energy efficiency and emission reduction account will be setup at the financial intermediary

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bank to retain all the interest spread to ensure it is used for intended purposes rather than being pooled into Shandong Economic and Information Technology Commission (SEITC) or Shandong Finance Bureau (SFB) general accounts. Up to 50% of the retained fund will be used for (a) PMO administration including funding for PMO expenses and staffing, and retaining independent implementation consultants to supplement the PMO’s shortage of expertise in project appraisal and monitoring; and (b) paying the financial intermediary bank’s management fees. (The other 50% will be used as reward to the subborrowers based on actual realized energy savings.) This will help ensure the sustainability of the PMO funding and the funding for retaining external expertise through the 15 years long tenure of this FIL.

Further, the Shandong PMO is a joint World Bank/ADB project management office, which is currently implementing GEF Project ID 3743 and other World Bank projects with tenures as long as 30 years. This will help create a larger and more stable staffing pool.

Other approaches for reducing energy demand are being designed. In addition to the Guangdong EPP and Shandong EE&ER Project, the Energy Efficiency Multi-Project Financing Program prepared by ADB’s Private Sector Operations Department in 2007 has a guarantee mechanism for domestic banks when a preselected ESCO provides the technical services for improving energy efficiency in buildings. The World Bank is preparing a normal FIL, which includes capacity building input from the Global Environment Facility; and another private sector proposal extends guarantees for loans offered by partner domestic banks to utility companies to help consumers improve their efficiency of gas and district heat use. Considering the extremely large potential for improving energy efficiency in the PRC, pilot implementation of various approaches is justified.

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APPENDIX C1: SUPPLEMENTARY COMPARISON WITH GUANGDONG ENERGY EFFICIENCY AND ENVIRONMENT IMPROVEMENT INVESTMENT PROGRAM

In 2008, Asian Development Bank’s Guangdong Energy Efficiency and Environment Improvement Investment Program 1 was implemented, which successfully introduced the onlending mechanism to finance energy efficiency retrofits in Guangdong Province. A comparison drawn between the two projects is presented in the table below:

Comparison of Guangdong Efficiency Power Plant and Shandong Energy Efficiency and Emission Reduction Financial Intermediation Loans Attribute Guangdong EPP Shandong EE&ER Industries in the Provinces Energy intensity in 2009 0.684 tsce per CNY10,000 GDP 1.072 tsce per CNY10,000 GDP in in 2009 (the second best in PRC) 2009 (ranking at no. 11 in PRC, at national average). Industrial characteristics Dominated by export oriented Dominated by energy-intensive consumer products, downstream midstream industries. industries.

Export industries in downstream Midstream industries tend to have sectors are sensitive to market longer planning range in years; changes and tend to have subprojects sizes tend to be planning ranges as short as medium to large. months; subproject sizes tend to be small. Financing and Investment Total ADB loan $100 million ADB loan $100 million ADB loan

Subloans amounting to an Subloans amounting to an estimated $400 million through estimated $307.9 million through revolving financing within 15 revolving financing within 15 years. years. Total investment $35 million for the first tranche, $209.5 million for the first batch involving eight subprojects. consisting of three subprojects. $22.06 million for the second tranche, involving six subprojects.

The total investment for the first A simulation model was done and it tranche is about $89.03 million, is estimated that the total with ADB lending of $35 million investment of $615.8 million will after replacing some result from the revolving of loans subborrowers during the during 15 years. implementation. Total investment for the second tranche is $66.14 million including $22.06 million of ADB loan.

Total investment of $142 million for all three tranches financed by

1 ADB. 2008. Report and Recommendation of the President to the Board of Directors: Proposed Multitranche Financing Facility and Administration of Grant for the People’s Republic of China for Guangdong Energy Efficiency and Environment Improvement Investment Program. Manila. C1-1

Attribute Guangdong EPP Shandong EE&ER the original loans. Additional Funding Sources ADB Grant ADB grant of $2 million from CEF None Provincial Energy Efficiency Guangdong Energy Efficiency SFD will establish the Shandong Fund Fund Energy Efficiency and Emission Funding generated from the Reduction Account to provide interest rate difference between support for the project. Funding of the FIL onlending rate and ADB this account will principally come rate will partly contribute to the from the retained interest spread fund. between the FIL onlending rate to the subborrowers and the interest (In addition or as part of its 10% rate of the ADB loan. contribution to the EPP project, GPG provides a total of $1.5 million to fund the PMO operation. Access to government No Maybe per latest State Council rewards Office Notice No. 25 regarding ESCO development. Outputs Projected total annual 98,433 tsce/yr for the first tranche 919,697 tsce/yr for three initial first energy saving of $35 million ADB loan. batch subprojects under $100 million original loan. Projected total annual FIL modality allows multiple About three roll over of fund is emission reduction rollovers and it is anticipated that anticipated over the 15 year loan first and second tranches will be tenure. revolved five times. First batch: CO2: 2,683,721 t/yr for First tranche: CO2: 232,660; SO2: three initial subprojects in the first 2,685. batch under $100 million loan; SO2: 22,088 t/yr; Pro-ESCO Over 67% onlending to seven A minimum of two ESCOs is middle users targeted for funding between 2011 (ESCOs/manufacturers) in the and 2020. first tranche loan. Subproject Contents Project focus Primary electricity saving Direct energy recovery/saving associated with upgrades of supporting the upgrades of transformers, VFD, HVAC and production processes or upgrade of lighting etc., plus limited CHP energy products (e.g., in the case boiler upgrade. of coal washing).

No electricity generation Electricity and steam generation as by-products in addition to electricity and steam savings.

Emission reduction as a Direct emission reduction. secondary result of electricity saving.

No additional revenue. Subproject Subprojects can generate financial return is accounted for additional revenues through by- solely as energy (primarily product sales in addition to electricity) saving. electricity/steam savings.

Subproject size $1.84 million to $40.0 million (the Expected to average at $26.8 C1-2

Attribute Guangdong EPP Shandong EE&ER largest ESCO is $13.8 million). million per subproject, with the The original subprojects contained initial subprojects ranged from $65 in the appraisal report were nine million to $76 million. small subprojects with the size of investment ranged from $0.91 It has been agreed with the million to $12.5 million. Four of the government to include subprojects nine original subprojects have ranging from $10 million and above been replaced with three larger for subsequent batches. size subprojects. Technical contents Sector-wide application of Application of advanced standard technologies, such as technologies in the industrial transformer upgrade, VFD and subsector. HVAC upgrade. Safeguard contents Social safeguard requirements Social safeguard requirements are are not applicable since not applicable since subprojects do subprojects do not include land not include land acquisition. acquisition.

Subprojects have to comply with Subprojects have to comply with ADB and national environmental ADB and national environmental safeguard requirements as laid safeguard requirements as laid out out in the environmental in the environmental and social assessment and review management system framework document. documentation. Specific Financial Intermediary Features Financial intermediary Multitranche financial Single tranche financial features intermediation loan intermediation loan

First tranche loan of $35 million, All $100 million loan onlended to subsequent tranches up to $65 three initial subprojects. million

Each new tranche needs to submit new PFR for ADB approval.

Subsequent onlending would Subsequent batches would require require no further approval from no further approval from ADB with ADB with the exception of ADB the exception of ADB review on the review on the subloans greater subloans greater than $15 million. than $10 million.

Loan tenure 15 years Loan tenure 15 years.

Financial intermediary functions Financial intermediary functions are primarily with the selected being split between the selected financial intermediary trust financial intermediary bank and company (GFTC). PMO.

Financial intermediary Interest spread retained in a management fees paid by GPG designated Energy Efficiency contribution. Account at the financial intermediary.

Guangdong Energy Efficiency 50% of retained interest spread

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Attribute Guangdong EPP Shandong EE&ER Fund has been setup to manage being used to pay financial energy saving rewards. intermediary management fees and fund PMO operations, including PMO staffing and hiring of professional services from third- party consultants. Interest incentives and Interest would be 10% discount Interest would be 10% discount rewards over PBC 6-month prime. over PBC prime for the equivalent term.

GPG contribute 10% of total 50% of retained interested spread investment to Guangdong Energy will be refunded to subprojects as Efficiency Fund which may rewards based on actual energy provide rewards to the savings incurred. subprojects based on verified energy savings. However, there has been no commitment to firm mechanism to the rewards. Repayment period Repayment period 3–5 years The payback period will need to (including 1 year grace period) match the repayment period of each batch of subprojects. Subborrower asset 20% of investment for the first 25% of total investment for all requirement tranche of subprojects. subprojects.

30% of investment for the second and third subprojects. Loan guarantee Asset collateral or third-party SFD guarantees to MOF, backed guarantor to financial intermediary by local government guarantees. (GFTC). PMO/Executing Agency PMO funding and staffing GPG provides a total of $1.5 PMO staffing and expenses would million to fund the PMO operation, be primarily funded from the other including expenses required for 50% retained interest spread to be identification/selection/appraisal of accumulated in the designated additional tranches of subprojects Energy Efficiency Account. and hiring third-party consultants for energy saving measurement and verification.

GPG provides five permanent head counts. Funding for external Partially funded by a companion Funding needs for hiring of consultant support ADB grant of $2 million from CEF professional services for and GPG contribution (part of the independent consultants would total contribution of $1.5 million). come from the designated Energy A shortlist of three international Efficiency Account. consultants has been pre-selected for monitoring and verification. Project solicitation and selection PMO PMO PMO leads the second and third tranches of subproject feasibility PMO only reviews the feasibility Feasibility study studies. study reports. Project appraisal/approval Financial intermediary (GFTC) PMO Procurement/disbursement PMO assumes centralized project PMO only supervises procurement C1-4

Attribute Guangdong EPP Shandong EE&ER management implementation and procurement activities, which is untaken by the functions on behalf of small subprojects subprojects.

Disbursement approval by PMO only reviews/approves financial intermediary (GFTC) disbursements prepared by subprojects. (Note: the first tranche loan took effect on 9 January 2009. As of June 2010, about 65% loan amount had been disbursed.) Monitoring and evaluation Managed by PMO using external Managed by PMO using external of results consultants. consultants. ADB = Asian Development Bank, CEF = Clean Energy Fund, CHP = combined heat and power, CNY = yuan, CO2 = carbon dioxide, EE&ER = energy efficiency and emission reduction, ESCO = energy service company, EPP = Efficiency Power Plant, FIL = financial intermediation loan, GDP = gross domestic product, GFTC = Guangdong Finance and Trust Company, GPG = Guangdong provincial government, HVAC = heating, ventilation, and air conditioning, MOF = Ministry of Finance, PBC = People’s Bank of China, PFR = periodic financing request, PMO = project management office, PRC = People’s Republic of China, SFD = Shandong Provincial Finance Department, SO2 = sulfur dioxide, t/yr = ton per year, tsce/yr = ton of standard coal equivalent per year, VFD = Variable Frequency Drivers . Source: Asian Development Bank.

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APPENDIX D: DESIGN AND MONITORING FRAMEWORK

DESIGN AND MONITORING FRAMEWORK

Performance Data Sources/Reporting Design Targets/Indicators Mechanisms Assumptions Summary and Risks Impact Assumptions Reduced industrial energy Shandong province National and provincial  The FIL modality allows about intensity and emissions in achieves its energy Statistical Yearbooks two rollovers and an additional

Shandong Province intensity and SO2 eight batches of subprojects. reduction targets for 11th National and provincial energy  Energy efficiency remains a and 12th Five year intensity data high priority. Development plan period  Sound macroeconomic (2006-2015). Annual air quality data from conditions encourage larger provincial EPB investment in energy efficiency.  Enhanced environmental regulations and standards are enforced.

Risk The FIL modality does not rollover funds as anticipated.

Outcomes Assumptions Expanded energy efficiency Subprojects in the first Energy audit reports of the  The demonstration effect kicks investments in batch achieve a subprojects prepared by the in from the timely energy-intensive industries of cumulative energy savings PMO by 2016 implementation of the priority Shandong Province of up to approximately projects. 920,000 tsce/yr by 2016 Loan review mission, PMO reports, financial intermediary  The PMO and financial By 2016, the financial progress reports intermediary actively pursue intermediary successfully more enterprises and ESCOs onlends to second batch of for further investments. energy efficiency and emission reduction Risks subprojects  The implementation of priority subprojects is delayed risking rollover of funds for future projects.  The complementary policy and regulations for encouraging energy efficiency do not

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encourage further investment.

Outputs Assumptions 1. Priority energy efficiency Subprojects in the first Quarterly progress reports,  Priority subprojects are and emission reduction batch achieve the loan review missions and implemented as appraised. projects implemented in following energy savings subproject performance and  The selected financial key energy-intensive and emission reductions: monitoring reports intermediary invests in these industries  Golden Yimeng priority subprojects and achieves an Subproject completion reports sufficient counterpart funds are approximate energy and financial reports available on time. savings of 95,448  The PMO retains trained staff, tsce/yr, 663,054 t/yr who use their skills and

of CO2, and 341 t/yr expertise well.

of SO2;  Local enterprises, financial  Lufang achieves institutions, and ESCOs actively approximately an participate. energy savings of 62,426 tsce/yr, Risks

159,241 t/yr of CO2,  Project implementation is

and 645 t/yr of SO2; delayed.  SMM achieves  The selected financial approximately an intermediary and PMO do not energy savings of perform satisfactorily. 761,823 tsce/yr, 1,861,426 t/yr of

CO2, and 21,102 t/yr

of SO2.

2. ESCO business Financial support is opportunities enhanced in provided to at least two Shandong Province ESCOs under the priority projects by 2020

3. Capacity developed for Organizational setup and government and financial procedures for institutions on planning performance monitoring and management of and verification of energy energy efficiency efficiency projects are in investments place by 2013

The PMO and financial intermediary appraise and onlends to the second batch of energy efficiency projects by 2016 through D-2

utilizing the escrow revolving account fund

Activities with Milestones Inputs

Activity 1: Investment in priority energy efficiency and emission reduction subprojects Initial Project Investment for 1.1 The first batch of energy efficiency subprojects are implemented in energy-intensive selected subprojects in the first industrial enterprises through financial intermediary (2011–2015). batch: $209.50 million 1.2 The financial intermediary model, set of criteria and relevant procedures including the  ADB loan for the selected ESMS are in place to support future projects in Shandong (2011). subprojects: $100 million 1.3 The PMO and financial intermediary are setup to (i) screen potential investment  Domestic loans secured by the subprojects for future support from the FIL, (ii) implement a performance and monitoring selected industrial enterprises: system for the projects under implementation, and (iii) report results to ADB (2011–2015). $46.56 million  Selected industrial enterprises' Activity 2: Energy service company business opportunities enhanced in Shandong equity: $62.94 million Province 2.1 Consult SPG's current and ongoing energy efficiency action plan to obtain background data on ESCO businesses in Shandong (2011). 2.2 Promote business opportunities for ESCOs through advertisement and awareness sessions (2011–2012). 2.3 Select ESCO companies based on the selection criteria agreed upon in the loan agreement with ADB (2011–2020).

Activity 3: Capacity strengthened in energy efficiency management 3.1 The PMO and financial intermediary capacity strengthened through hands-on involvement in financing and monitoring priority energy efficiency and emission reduction projects (2011–2022).

ADB = Asian Development Bank, CO2 = carbon dioxide, EPB = environmental protection bureau, ESCO = energy service company, ESMS = Environmental and Social Management System, FIL = financial intermediation loan, PMO =

project management office, SO2 = sulfur dioxide, SPG = Shandong Provincial Government, t/yr = ton per year, tsce/yr = ton of standard coal equivalent per year. Source: Asian Development Bank.

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APPENDIX E: ESTIMATED ENERGY SAVINGS AND EMISSION REDUCTION FOR INITIAL SUBPROJECTS

Appendix E1

Biogas Power Generation, Waste Heat Recovery and Solar Thermal Utilization Subproject by Shandong Golden Yimeng Group (Golden Yimeng)

1. Estimation of Energy Saving

The energy savings of this subproject are mainly from five project elements, namely biogas power generation, waste heat recovery, solar energy utilization, bio-waste utilization and energy savings resulted from process upgrades.

The Golden Yimeng Subproject will expand the designed capacity of the biogas generation system to 12,000 Nm3/h, which can increase biogas production from the existing 19 million m3/yr to 78.55 million m3/yr. The biogas is used for power and steam generation. Assuming the methane concentration of biogas is 54%, the heating value of biogas is about 5108 kcal/m3, the increased biogas (59.55 million m3) is equivalent to 43,450 tsce/yr.

The waste heat recovery from distillation residues (also called “lees”) can achieve energy saving of 8,792tscetsce, while energy consumption for the waste heat recovery is 21 6MWh, equal to 75.6 tsce, therefore the net energy saving is 8,716.4 tsce/yr.

Solar thermal technology is used for solar energy recovery to preheat boiler feed water; the total proposed solar thermal receiving area is 20,000m2, which can achieve energy saving of 3,940 tsce/yr.

Anaerobic sludge treatment and utilization can generate 50,000 t/yr organic fertilizer and 40,600 t/yr biofuel. The heat value of the bio-fuel is 9,210 kJ/kg. The bio-fuel is used as boiler fuel and save 12,757 tsce/yr coal fuel. Meanwhile the anaerobic sludge treatment requires 3505 tsce energy consumption for organic fertilizer production and 2676 tsce energy consumption for bio-fuel production. Therefore the net energy saving of this subproject component is 6576 tsce/yr.

Energy savings resulted from process upgrades, mainly for aldehyde and acetate ester production system, can save energy by 32,778 tsce, while the increased energy consumption is only 12.6 tsce. Therefore the net energy saving is 32,766 tsce/yr.

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In summary, the total net energy saving is estimated at 95,448 tsce/yr as detailed in Table E1.

Table E1: Energy conservation estimation of the Golden Yimeng Subproject (tsce/yr) No. Item Energy Increased Energy Net Energy Saved Consumption Saving 1 Biogas power generation and 43,450 0 43,450 heat supply 2 Waste heat recovery 8,792 75.6 8716.4 3 Solar thermal energy utilization 3,940 0 3,940 system 4 Process upgrade of aldehyde 32,778 12.6 32,766 and acetate esters production systems 5. Anaerobic sludge treatment 12,757 6,181 6,576 and utilization system Total 101,717 6,269 95,448

2. Estimation of Emission Reduction

2.1 Estimation of CO2 Emission Reduction

According to the 2006 IPCC Guidelines for National Greenhouse Gas Inventories, the emission factors of coal and natural gas are 87,300 kg CO2/TJ and 54,300 kg CO2/TJ respectively, which means combustion of 1tsce coal would emit 2.55tCO2, and 1t CH4 would emit 2.75 tCO2.

3 The use of 59.55 million m /a biogas (54% CH4) can reduce methane emission of 3 32.16 million m /a , or 21,545 tCH4, therefore the CO2 emission reduction from the use of biogas is about 452,449 tCO2. The biogas power generation (2x6MW) plant could supply 39.74 million kWh, or the increased biogas use can supply 30.13 million kWh electricity, according the latest emission factor calculation results of power grid issued by National Development and Reform Commission, the emission factor of North

China Power Grid is 0.8936tCO2/MWh, therefore, CO2 emission reduction from power generation is about 26,924t. The biogas use system can supply 1.50x106GJ steam, or the increased biogas use (59.55 million m3/a) can supply 1.14x106GJ steam, assuming the thermal efficiency of coal fired boiler is 90%, the system can save

43,269 tsce for steam generation, the CO2 emission reduction from steam generation is 110,336 t. Meanwhile, the combustion of methane would emit 59,249 tCO2/a,

Therefore the net CO2 emission reduction of the biogas power and steam generation system is estimated to be 530,460t/yr.

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Regarding CO2 emission reduction from other components, for simple calculation, net energy saved is used for emission reduction calculation, and emission factor of 2.55 tCO2/tsce is adopted. The calculated results are shown in Table E2. The CO2 emission reduction from other components is 132,595 t/yr.

The total CO2 emission reduction of the Golden Yimeng subproject is 663,054 t/yr as detailed in Table E2.

Table E2: Estimation of CO2 emission reduction from Golden Yimeng subproject

No. Item Net CO2 Emission Reduction (t/yr) 1. Biogas power generation and heat 530,460 supply Other Subproject Components 132,595 2 Waste heat recovery 22,226 3 Solar energy utilization system 10,047 4 Technical upgrade of aldehyde 83,553 ester production system 5 Anaerobic sludge treatment and 16,769 utilization system Total 663,054

2.2. Estimation of SO2 Emission Reduction

Without biogas, waste heat recovery and solar energy use, more coal will be combusted at circular fluidized bed boilers to supply heat and electricity for the operation of Golden Yimeng factories. For the circular fluidized bed coal combustion system, the sulfur removal efficiency is about 85%. In addition, the following assumptions of fuel coal are made: ash content 25%, average sulfur content 1.0%, sulfur conversation rate 85%.

As the total net energy saving is 95,448 tsce, equivalent to 133,627t bituminous coal (5,000 kcal/kg). Without the Golden Yimeng Subproject, coal has to be used to produce the steam and electricity; and SO2 emission factor of coal can be calculated by following formula:

GSO2=2x1000xSxP.x(1-ηSO2) ………………………………..(1) where:

GSO2 - SO2 emission factor (kg/t coal);

S – sulfur content (%)

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P – Sulfur convention rate (%)

ηSO2 – sulfur removal efficiency (%)

Based on the above assumptions: the SO2 emission factor of coal is

GSO2=2x1000x1%x85%x(1-85%) = 2.55 (kg/t coal)

Therefore, when 133,627 ton coal is combusted, the SO2 emission would reach 341 t.

As use of biogas and waste heat does not emit SO2, the net SO2 emission reduction of Golden Yimeng subproject is 341 t/yr.

2.3. Estimation of Other Pollutant Emission Reductions

Regarding smoke emission factor of coal, the following formula can be used:

G smoke=1000xAxαx (1-ηSmoke)/((1-C)xK)……………………………………(2) where:

Gsmoke – smoke emission factor (kg/t coal);

A – Ash content of coal (%),

α – share of fly ash in the smoke (%);

ηSmoke – PM removal efficiency (%)

C – carbon content in the smoke (%)

K—boiler output factor

Assuming the circular fluidized bed (CFB) boiler is used, the ash content of coal is 25%, dust removal efficiency is 99%, share of fly ash in the smoke is 55%, carbon content in the smoke is 3%, boiler output factor is 1, then the smoke emission factor of coal is (source: Handbook for Industrial Pollution Generation and Emission Coefficient, issued by the State Administration of Environmental Protection in 1996):

G smoke=1000x25%x55%x (1-99%)/((1-3%)x1)= 1.42 (kg/ t coal)

Therefore, when 133,627t bituminous coal is combusted, the smoke emission would reach 190 t. The implementation of the subproject can reduce PM emission by 190 t/yr.

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The NOX and CO emission factor of CFB coal boilers is 5.77kg/t coal and 2.07kg/t coal, therefore the Golden Yimeng subproject can achieve the emission reductions of

771 t/yr NOx and 277 t/yr CO.

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Appendix E2

Flue Gas Heat Recovery and Emission Reduction Subproject By Shandong Lufang Metallic Material Co., Ltd. (Lufang)

1. Estimation of Energy Savings

The Lufang subproject achieves energy conservation by waste heat recovery from flue gas treatment systems and the sulfuric acid reaction system.

The Organic Rankine Cycle (ORC) system is to recover waste heat from 200,000-250,000 m3/h mid-temperature flue gas and from the sulfuric acid reaction system. The waste heat is used produce steam, with low pressure steam production of 239,263 t/a , assuming the heating value for the steam is 0.1286kgce/kg, the waste heat recovery for steam production can save 30,769 tsce/yr energy.

The high temperature flue gas from the oxygen bottom blown furnace (OBBF) and Basic Oxygen Converter Furnaces can produce 52.95 t/h to 54.75t/h mid-pressure steam, which can drive 5,680kW generating sets. The annual electricity generated can reach 48.98 million kWh, equivalent to 17,143tsce. The exhausting low pressure steam would be 112,860 t steam/yr, equal to 14,514 tsce energy. Therefore the improved waste heat recovery system can achieve energy conservation of 31,657 tsce/yr.

The total energy saving of the subproject is 62,426 tsce/yr.

2. Estimation of Emission Reduction

2.1. Estimation of CO2 Emission Reduction

The CO2 emission reduction is mainly from waste heat power generation, the Subproject uses waste heat recovered to produce steam and drive steam turbine for power generation. The total installed capacity is 5,680 kW, which can produce electricity of 48.98 million kWh/yr. Without the subproject, the electricity will be supplied by North China Power Grid, of which the CO2 emission factor is 0.8936 tCO2/MWh, therefore the electricity generated from waste heat can reduce the emission of 43,769 tCO2./yr. The waste heat is also used for steam supply. With an annual steam supply of 352,123 t, it can save 45,283 tsce energy. As the emission factor of coal is 2.55 tCO2/tsce, the steam production by waste heat can reduce

115,472 tCO2. Therefore the total CO2 emission reduction of the subproject is 159,241 t/yr.

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2.2. Estimation of SO2 Emission Reduction

The subproject adopts the “Double Conversion and Double Adsorption” process to convert SO2 in OBBF/BOF flue gases (12% v/v) to SO3 and absorb the SO3 to make sulfuric acid. The exhausting gas in combination with other stream of flue gases are then treated by a desulfurization process. The combined SO2 removal efficiency can reach 99.85% removal. The SO2 concentration in the final emission would be less than 100 mg/m3 or 68.73kg/h (or 544t/yr for 330 production days per year), much lower than the applicable GB16297-1996 Class II Emission Limit of 960 mg/m3 and

110 kg/h (or 871t/a), compared with national standard for SO2 emission The SO2 emission reduction of the flue gas desulfurization system is 327t. In addition, waste heat based electricity generation can also reduce SO2 emission which is otherwise caused by coal fired power plants. Regarding the SO2 emission factor from coal fired power generation, the 2008 average emission factor (4.15 kg SO2/MWh) of China’s top 5 power companies is adopted. The waste heat generates 48.97 million kWh/yr electricity and can avoid emission of 203 tSO2/yr. In addition, the steam production by waste heat can save 45,283tsce coal (or 63,396t coal with heating value of

5000kcal/kg), as the emission factor of coal is 2.55 kg/t coal, the SO2 emission reduction is estimated at 115t. Therefore the total SO2 emission reduction of the Lufang subproject is 646t/yr.

2.3. Estimation of Other Pollutant Emission Reduction.

Without the subproject, approximately 62,426 tsce or 87,396 t fuel coal (at 5000kcal/kg) would be required per annum to produce the electricity and steam.

Assuming the smoke, NOX and CO, emission factors of fuel coal are 1.42 kg/ t, 5.77 kg/t and 2.07 kg/t, respectively, the emission reduction of the Lufang subproject can reach 124t/yr PM, 504 t/yr NOx and 181t/yr CO.

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Appendix E3

Coal Washing Service Subproject By Shandong Mining Machinery Group (SMM)

1. Estimation of Energy Savings

Energy savings from the SMM subproject mainly include the improved energy efficiency of coal fired boilers due to use of clean coal, recovery of fine coal and avoided transportation of coal waste by railway.

The subproject will provide coal washing service for a total processing capacity of 20 Mt/yr. It can avoid combustion of 20Mt raw coal annually. Use of clean coal can increase the thermal efficiency of coal fired boiler by 3-8%. Assuming the average increased thermal efficiency is 5.30%, the energy saving by coal washing can reach 761,823 tsce/yr.

According to the feasibility study report, with the SMM’s advanced fine coal recovery technology, the fine coal recovery can increase by 5% in comparison with the conventional fine coal recovery technology; the total clean coal recovery would increase by 0.265%. For the 20 Mt/yr coal washing capacity, the annual clean coal production would reach 16.8 Mt; the increased clean coal recovery is estimated at 31,800 tsce per year.

As well, direct energy saving is resulted from avoidance of railway transport of waste coal. The washing 20Mt raw coal can remove 3.20Mt waste coal. Assuming the average transport distance to the end users is 600 km, the avoided waste coal transport would reach 1.92 billion t-km. According to the energy efficiency target of railway transport, the energy consumption per million t-km is within 7.75 tsce; therefore, the avoidance on waste coal transport can save energy consumption by 14,880 tsce/yr.

Meanwhile, coal washing of 20Mt/a would consume 120 million KWh electricity, which is equal to consume 42,000 tsce energy.

Therefore, the net energy saving of the SMM subproject is estimated to be 761,823 tsce/yr.

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2. Estimation of Emission Reduction

2.1. Estimation of CO2 Emission Reduction

The energy saving by coal washing can reach 757,143 tsce/yr; the emission factor of

1 tsce is 2.55 tCO2, therefore the energy saved would result in CO2 emission reduction by 1,930,714t/yr. The recovered fine clean coal also emits CO2 during combustion and hence results in no CO2 emission reduction. The avoidance on waste coal transport can save energy consumption by 14,880 tsce/yr, which is equivalent to

37,944t CO2/yr. Meanwhile, washing 20Mt raw coal would consume 120 million KWh electricity. Using the emission factor of North China Power Grid of 0.8936 tCO2/MWh, the coal washing plants will cause emission of 107,232t CO2. The net CO2 emission reduction of the SMM subproject is 1,861,426 t/yr.

2.2. Estimation of SO2 Emission Reduction

Coal washing can remove 60-80% inorganic sulfur in raw coal; and inorganic sulfur usually accounts for 60% of total sulfur of raw coal. During the conventional coal washing, organic sulfur cannot be removed. Assuming the average inorganic sulfur removal efficiency is 60% and average sulfur content of raw coal is 1.0 %. By coal washing, the total sulfur removal efficiency could reach 36% (60%*60%). Therefore washing of 20Mt coal can remove 72,000t inorganic sulfur. Assuming average sulfur removal efficiency of flue gas from coal combustion at various boilers is 85%, if the above inorganic sulfur has not be removed by coal washing, it would result in 21,600 t/yr SO2 emission reduction at coal boilers. However, electricity consumption at coal washing plants will indirectly result in SO2 emission. Regarding the SO2 emission factor from coal fired power generation, the 2008 average emission factor (4.15 kg

SO2/MWh) of China’s top 5 power companies is adopted, the SO2 emission due to electricity consumption is 498 t. Therefore, when The SMM subproject is put into full operation, it can result in net SO2 emission reduction by 21,102 t/yr.

2.3. Estimation of Other Pollutant Emission Reduction

As coal transport consumes diesel and electricity and fine coal recovery only increase the clean coal production, only the energy saved through energy efficiency improvement at coal boilers is taken into account for the calculation of other emission reduction. The 757,143 tsce energy saved per year is equivalent to 1,060,000t fuel coal (at 5000kcal/kg). Assuming the smoke, NOX and CO, emission factors are 1.42 kg/ t, 5.77 kg/t and 2.07kg/t respectively, the calculated reduction of PM, NOx and CO emissions resulted from the implementation of SMM subproject would be 1,505 t/yr

PM, 6,116t/yr NOx and 2,194t/yr CO, respectively.

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Appendix E4

Summary of Energy Savings and Emission Reduction by Initial Subprojects

The initial three subprojects have notable energy conservation and emission reduction benefits. The total energy saving from the three initial subprojects is estimated to be 919,694 tsce/yr. The total calculated annual emission reductions of the three subprojects would include 2,683,591 t CO2, 22,088 t SO2, 1,819 t PM, 7,413 t

NOx and 2,652 t CO. A summary of the emission reduction figures is provided in Table E3.

Table E3: Summary of energy conservation and emission reduction estimates for the three initial subprojects Item Golden Yimeng SMM Lufang Total

Energy Saving (tsce/yr) 95,448 761,823 62,426 919,697

CO2 (t/yr) 663,054 1,861,426 159,241 2,683,721

SO2 (t/yr) 341 21,102 646 22,088 Smoke (t/yr) 190 1505 124 1,819

NOx (t/yr) 771 6116 504 7,391 CO (t/yr) 277 2194 181 2,652 Sources: Subproject feasibility study reports and Asian Development Bank estimates.

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APPENDIX F: DETAILED COST ESTIMATES

Appendix F1

Methane Power Generation, Waste Heat Recovery and Solar Thermal Utilization Subproject by Golden Yimeng Group Ltd.

Golden Yimeng Group Inc. (Golden Yimeng) is based in Linshu County, Linyi Municipality, Shandong. Golden Yimeng was previously the Linshu County Chemical Plant established in 1975. It was later transformed into a private share-holding company with main shareholders being Mr. Zhang LiSheng and his family. Golden Yimeng ranks 143rd amongst the top 500 enterprises and 3rd amongst top 50 specialty chemical manufacturers in China. Its main production includes fertilizers (ammonia production and organic fertilizers), acetate esters and carboxylic acid aldehydes, and fermentation alcohols. It is ranked as the number one producer of acetate esters with a market share of 20% in China. It is also a leading producer of industrial fermentation alcohols in China, ranking at top 6 while top 1 in Cassava root fermentation subsector. It operates a Cassava root production base in Thailand and imports Cassava root from the Southeast Asia as fermentation raw materials. Its production hence generates biomass as by products for organic or composite fertilizers. Its overall fertilizer production capacity is approximately 1 million tons per year and ester acetate/carboxylic aldehydes production capacity of some 800,000 tons per year.

A. Project Scope of Subproject

Under this subproject, (Golden Yimeng) has proposed the following five components:

1. Expansion of the biogas capturing system associated with the organic wastewater treatment system to approximately 12,000 Nm3/h from the current 3000 Nm3/h, which will be used to fuel two methane gas boilers that will be modified from two existing coal-fired boilers, to generate 39744 MWh electricity per annum through a mid-pressure steam turbine of 6000 kW capacity. The resulted low-pressure stream of 1,500,000 GJ heat value per annum will be supplied to the industrial end users with the industrial park and domestic users in the adjacent community;

2. The flue gas from the existing biogas boiler will be used to dry the bio-wastes from the wastewater treatment system which has high moisture contents. The dried sludge of over 40,000 t/yr (dry weight) will then be used as boiler fuel, co-firing with coal used by the existing coal-fired boilers. The bio-waste use can replace coal consumption by 12,757 tsce/yr. Meanwhile the bio-waste from alcohol distillation system of approximately 50,000 t/yr (dry weight) will be used to produce organic fertilizers;

3. An integrated waste heat recovery and solar thermal system will preheat the boiler feed water (approximately 220 t/h) from approximately 40oC to 80oC through heat exchange with hot wastewater and further raise the water temperature using a solar thermal system to 140oC to feed the coal-fired boilers and to 104oC to the feed biogas boiler. This will result in saving of coal fuel by 12,732 tsce/yr;

4. Upgrades of organic aldehyde production systems include (i) retrofits of evaporation pans, heat exchangers and adsorption towers (with better heat transfer efficiency) and air

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blowers (with VFD motors); (ii) condensate recovery for softened water; (iii) heat recovery from process liquid/wastewater recirculation and (iv) upgrade of oxidation furnace and associated offgas treatment system with better combustion and heat exchange efficiency. The proposed upgrades on the organic aldehyde production systems will result in savings of electricity by 1,666 MW/yr, mid-pressure saturated steam by 30,000 tons/yr, low pressure superheat steam by 37,000 t/yr, softened water by 36,060 m3/yr and other energy savings by 7,050 tsce/yr; and

5. Upgrade of the acetic ester system includes primarily upgrades of esterification column and dehydration tower, which will result in saving of low pressure superheat steam by 200,000 t/yr.

B. Process Description

1. Biogas Power Generation and Heat Recovery/Supply

This project component is expected to increase the capacity of the first phase anaerobic pretreatment system from 3,500m3/d to 15,000m3/d; and the second phase thermophilic fermentation treatment from 10,000m3/d to 30,000m3/d (both of the two phases of the anaerobic treatment adopt IC anaerobic reactor).

The anaerobic wastewater treatment processes are expected to generate 10,910Nm3/h biogas. 3 The biogas would contain 54% CH4 with a heat value of 21,384kJ/ Nm . The biogas will be used to fuel two gas boilers to generate medium-temperature and medium-pressure steam by 63.6t/hr. It is proposed that two existing medium-temperature and medium-pressure coal-fired chain boilers of 2×35t/h capacity each be converted into gas-fired boilers. The generated steam will be used to drive an existing 6MW back-pressure steam turbine generator. The co-generation system will then have an output capacity of 6,000kW electricity and 62t/h low pressure steam. Assuming an operational time of 7,200hr/yr, the biogas fired cogeneration system can supply 4,320×104kWh electricity, with net 3,974.4×104kWh for external supply, and 150×104GJ/yr heat in the form of low pressure steam.

The overall heat efficiency for the above proposed co-generation system is estimated to be over 83%. Alternatively, advanced biogas turbine generators followed by flue gas heat recovery boilers can achieve an overall system heat efficiency of over 86% by producing more electricity but less heat/steam. However, such alternative would not allow for full utilization of the residual value of the existing boilers nor provide better investment because of distorted local electricity pricing. A detailed steam balance calculation and least-cost analysis will be undertaken during the detailed design, in conjunction with the other proposed project components discussed below, to support the final decision.

The key parameters of the steam supply are as follows:

Design Capacity Pressure Temperature (t/h) (MPa) (oC) 62 0.49 223

The generated steam will provide district heating to the residential communities in the nearby Linshu county for a total floor area of 500,000 m2 through a 3000 m overhead pipeline of DN300. The residential heating index is 230kJ/m2.h and hence the heating load is 115GJ/h for the heating period is 120 days during the winter. The heat will be delivered to individual residential

F1-2 end users by converting the steam to hot water at community heat exchange stations. The heat exchange stations, one station per community, will be converted from the existing heat supply boiler rooms located in the communities. The proposed project hence would not include the hot water lines within each community.

The balance of the generated steam will be supplied to various industrial users in the industrial park via two 6,000 m overhead pipeline of DN500 each. A schematic of the above described system is provided below.

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Schematic of Biogas Power Generation and Heat Recovery/Supply System

Sludge deposit

Organic Chemical Liquid Waste FRP Cooling Tower

Steam Pipeline 2×104m3 Treated Biogas 1×3,000m DN300 Hot Water

Steam Pipeline 2×6,000m DN500 Electricity generated 3,974.4×104kWh 104ºC Soft Water Preheated Industrial Use by Solar Thermal, 67m3/hr

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2. Waste Heat Recovery and Solar Thermal Utilization

This project component is proposed to recover waste heat from process wastewater and utilize mid and high-temperature parabolic solar thermal systems by preheating boiler feed water so as to save the coal consumption by the boilers. The waste heat recovery system will first preheat the boiler feed water from 40oC to 79.5oC through heat exchange with hot wastewater from the crude distillation towers, which cool the wastewater down from 105oC to 60oC prior to treatment by at the wastewater treatment plant. After being preheated to 79.5oC by the waste heat recovery system, the boiler feed water will further be heated by a solar parabolic thermal system, to140℃ for the coal-fired boiler and 104℃ for the biogas fueled boilers, respectively.

The solar parabolic thermal system utilizes the parabolic reflector to focus the solar radiation to vacuum tube heat collector, which will heat the heat transfer media enclosed in a closed loop. The project utilizes the middle and high-temperature solar parabolic technology to heat the boiler feed water through heat exchange. The total designed area of the solar thermal panel will be 15,000m2, which will be sufficient to heat 220m3/h boiler feed water to 104℃ for two 35t/h biogas-fueled boilers and 150t/h coal-fired boiler, respectively. A schematic flow chart of the proposed waste heat recovery and solar thermal system is provided below.

Solar parabolic system 150t/h Boiler 140ºC

Heat exchanger 2×35t/h Biogas Boiler 104ºC

WWTP

60ºC wastewater 79.5ºC Boiler Soft Water pump 40ºC, 217t/h

105ºC wastewater Flowchart of Solar Parabolic Water Heating System Amylum Fermentation

3. Anaerobic Sludge Utilization

This subproject component includes the utilization of anaerobic sludge to produce organic fertilizer and the use of flue gas waste heat to dry sludge. The dried sludge can then be used as supplemental fuel to the coal-fired boilers. There is 271,800 t/yr wet sludge generated in the

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anaerobic processes, containing 75% water, which would be equivalent to 90,600 t/yr dry sludge, containing 25% water. Of the total 90,600 t/yr sludge in dry weight, 50,000 t/yr will be used to produce organic fertilizer. A schematic of the organic fertilizer production is provided below.

Fly Ash

Contain 55% water

Multiple species inoculant

Contain 30% water

The balance of 40,600t/yr waste sludge can be as fuel. The heat value of sludge is approximately 9,209kJ/kg dry weight. But it will not have net positive energy contribution when it contains 75% water. The following is the schematic of the proposed sludge drying system which uses the flue gas from the coal-fired boiler to dry the sludge to reduce the water content to 25% prior to feeding the coal-fired boiler as fuel.

Flowchart of Sludge Drying by Flue Gas

Conveyor Belt Biogas Generation System

Processing capacity 12.5t/h Boiler Flue Gas 125-130ºC

Biogas Boiler

To Emission Stack Coal-fired Boiler F1-6

4. Process Upgrade and Energy Conservation for Organic Aldehyde Production Systems

4.1 Formaldehyde Production System The project is expected to upgrade the two existing formaldehyde production facilities with 75,000t/yr output each on oxidation furnace, evaporation pan, adsorption towers (with better heat transfer efficiency) and air blowers (with VFD motors). Upgrade of oxidation furnace and associated offgas treatment system with better combustion and heat exchange efficiency will result in generation of additional 30,000 t/yr mid-pressure saturated steam.

4.2 Acetaldehyde Production System.

The project is expected to update technology for alcohol oxidation process of acetaldehyde production system with 80,000t/yr output by introducing advanced domestic energy-saving oxidation furnace and VFD air fan motors. As well, upgrade of the absorption and distillation towers and adoption of new titanium wastewater heat exchanger will allow for the recovery of wastewater residual heat from alcohol recovery tower, resulting energy saving for 4,365 tsce/yr. Further, collection of condensate water to the hot water tank for the reuse at the oxidation furnace will save softened water by 36,060 m3/yr. For the purpose of heat recovery, using the flash steam from the top of hot water tank instead of the regular hot water to pre-heat the alcohol will save energy by 1,542 tsce/yr.

4.3 Glyoxal Production System The project is expected to upgrade the glyoxal production system with 20,000t/yr output primarily on oxidation furnace, adsorption towers (with better heat transfer efficiency) and air blowers (with VFD motors). As well, the pre-heaters of two distillation tower during the purification process will be upgraded to substitute the steam with recirculating liquid of the first absorption tower to preheat the feedstock of the distillation tower, which will preheat the crude glyoxal from 25℃ to 75℃.

With the above, the upgrades on the organic aldehyde production systems will result in savings of electricity by 1,666 MW/yr, mid-pressure saturated steam by 30,000 tons/yr, low pressure superheat steam by 37,000 tons/yr, softened water by 36,060 m3/yr and other energy savings in 7,050 tsce/yr.

5. Process Upgrade and Energy Conservation for Ester Acetate System The upgrade of the acetic ester system includes primarily upgrades of esterification column and dehydration tower, which will result in saving of low pressure superheat steam by 200,000 t/yr.

C. Summary of Energy Savings and Emission Reduction Overall, with the implementation of the above project components, the total annual energy saving is expected to reach 95,448 tsce, the annual emission reduction of CO2 is expected to be 663,054 t, SO2 341 t and PM 190 t. As well, it subproject reduced anaerobic sludge by 271,800 t/yr. A breakdown of the above energy saving and emission reduction figures is provided below. According to a 2007 energy audit report, Golden Yimeng’s total and sole fuel consumption in 2006 was 233,994 tsce. The estimated energy savings resulted from the above proposed subproject components would be equivalent to 40% of its total fuel consumption in 2006.

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Energy Total Net Saving per Ubproject Engineering Energy Emission Reduction Remarks 10,000 CNY Costs Saving Cost

(million CNY) (tsce/yr) (tsce/yr) (t CO2/yr) (t SO2/yr) Electricity Biogas power 39744MWh/yr generation & heat 132.20 43,450 32,900 530,460 155.12 Heat 15000000 supply GJ/yr Heat recovery & Coal saving 75.26 12,656 16,900 32,273 45.36 solar thermal 12705.45 tsce/yr Coal saving Sludge utilization 32.11 6,576 20,500 16,769 23.48 6576.12 tsce/yr Upgrade of See note 1 organic aldehyde 57.04 12,770 22,400 32,565 45.62 systems Low-pressure Upgrade of acetic 43.20 19,996 46,300 50,987 71.38 superheated ester system steam 200,000t/yr Total 339.81 95,448 28,100 663,054 341 Notes: 1. Savings include additional 0.75MPa saturated steam 30,000 t/yr, electricity saving 1,665.6MWh/yr, savings of low-pressure and superhot steam 37,000t/yr, saving of softened water 36,060m3/yr, and other heat recovery equivalent to 7,050 tsce/yr.

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Appendix F2

Flue Gas Heat Recovery and Emission Reduction Subproject by Dongying Lufang Metallic Materials Co. Ltd.

The subproject sponsor, Dongying Lufang Metallic Material Co. Ltd. (Lufang), is a wholly-owned subsidiary of Dongying FangYuan Non-Ferrous Metals Co. Ltd. Established in 1998, Dongying FangYuan Non-Ferrous Metals Co. Ltd. is reportedly the number one private–owned industrial enterprises in China, with a total revenue of over CNY12.0 billion in 2008. It core business is in manufacturing, recycling and sales of non-ferrous metals, including gold, silver, copper, nickel, primarily copper, and associated by-products, including oxygen gas, sulfuric acid and other chemicals. It is ranked at 440 amongst the top 500 industrial enterprises in China and is the top 6th copper producer in the country. In 2008, its refined anode copper production was over 200,000 tons. According to the submitted feasibility study report, the company currently has some 2000 employees and a total asset of over CNY4.5billion. It operates three industrial parks with a combined total land area of 4500 mu (3 million m2).

The proposed flue gas heat recovery and desulfurization project supplements a multi-metal ore smelting system of Lufang, which has a designed ore processing capacity of 1 million t/yr with approximate blister copper production capacity of approximately 200,000 t/yr. The ore smelting furnace uses the proprietary Oxygen Bottom Blown Smelting technology developed by China Enfei Engineering Technology Co., Ltd. (Enfei). Enfi pioneered the first industrial scale trial of the Oxygen Bottom-Blown Smelting technology in copper production at the Tai Lung copper smelter plant in Vietnam, with a nominal production capacity of 10,000 t/yr. Lufang smelter was the first full scale application of the Oxygen Bottom Blown Smelting technology in copper production. More importantly, through its Phase I process optimization, the smelting/reaction furnace of 50,000 t/yr design capacity has now become a virtual “Zero Carbon” process. Unlike other conventional blister copper smelting technologies which require a mix 3-6% coal or coke to the ores in the feedstock as fuel, the Enfei “Zero Carbon” technology requires virtually no coal/coke mix with the ores in the feed stock, with the exception of the fire-up period. The phase II of oxygen bottom blown smelting furnace is the first “Zero Carbon” blister copper smelting furnace by design in the world. Without the need for coal/coke addition as fuel, the “Zero Carbon” technology reduces direct CO2 emission by 110 – 220 kg CO2/t ore or 800 kg/t blister copper. As well, the elimination of coal addition will further reduce the oxygen demand which would consume electricity to generate, resulting in indirect reduction of CO2 and SO2 emission.

This major breakthrough in the copper smelting technology has been identified by the F2-1

State Council in 2009 as a national backbone technology, which will set the new market entry standard for future copper smelters with profound impact on the EEER efforts in the copper manufacturing industry in China.

A. Proposed Scope of Subproject

The proposed flue gas heat recovery and emission reduction subproject consists of the following components:

 Waste heat recovery by three high temperature heat recovery steam boilers (HRSBs), including one boiler of 28.75t/h capacity following the oxygen bottom-blown smelting furnace (OBBF) and three boilers of 12.1t/h to 13.0t/h capacity each following each of the three converting furnaces (CFs). The high temperature HRSBs will cool high temperature flue gas from 750oC-850 oC to approximately 350oC to produce mid-pressure steam (steam pressure 4.0 MPa, T 250oC) for power generation. The generated mid-pressure steam totaled at 52.95 t/h to 54.75t/h is fed to a steam turbine power generation station to generate 4640 kW to 5680kW electricity (10kV/50Hz);

 Waste heat recovery by four mid temperature HRSBs, including two boilers of 5.0t/h each capacity (steam pressure 0.8MPa, T170oC) following the two sets of settlement and anode furnaces (AFs), respectively, and two other boilers of 12.4t/h capacity and 14.4 t/h capacity (steam pressure 0.6MPa ， T159oC) associated with stage 3 and stage 4 sulfuric acid reaction processes. The mid temperature HRSBs will cool mid temperature flue gas from 650oC-750oC to approximately 180oC to 250oC to produce low-pressure steam for process use and winter heating;

 Flue gas from OBBF and CFs will then be treated by electrostatic precipitator (ESP) for dust removal and followed by a sudden temperature drop process, from o o some 350 C to 120 C, to recover As2O3 in particulates as a by-product for cost recovery;

 The treated flue gas containing SO2 concentration of approximately12% will be

subject to a 4-stage sulfuric reaction process to convert SO2 to sulfuric acid as a by-product for cost recovery, resulting in approximately 890,000 t/yr of 98% industrial sulfuric acid; and

 The offgas from the sulfuric acid production process would contain SO2 up to 775 mg/m3, which will be combined with the AF flue gas as well as smokes from other sources of the smelter plant, and be treated by a semi-dry

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method-limestone moving bed technology for desulfurization. The combined flue 3 3 gas of 687,405 Nm /h containing a SO2 concentration of 700 mg/m will be treated

to remove 90% SO2, resulting in the final SO2 emission concentration of ≤100 mg/m3 (or ≤68.73 kg/h).

B. Process Description

1． Flue Gas Waste Heat Recovery

This process include use of four HRSBs to cool high-temperature flue gas from 750oC -850oC to approximately 350oC to produce mid-pressure steam (steam pressure 4.0 mPa, T 250℃) for process heating and power generation. The generated mid-pressure steam totaled at 52.95 t/hr - 54.75 t/hr is fed to a power generation station to generate 4640kW～5680kW electricity (10kV/50Hz). The residual low pressure stream will be used for heat supply to production process and winter heating.

Four other HRSBs will be used cool mid-temperature flue gas from 650oC – 750oC to approximately 180oC to 250oC to produce low-pressure steam for process use and winter heating, including two boilers of 5.0 t/hr each capacity associated with AF (steam pressure 0.8 MPa, T 170oC), respectively and two boilers of 12.4 t/hr capacity and 14.4 t/hr capacity associated with the stage 3 and stage 4 sulfuric acid reaction processes (steam pressure 0.6 MPa，T 159oC), respectively. The main parameters for the above boilers are tabulated below.

Flue Gas Flue Gas Dust Boiler Steam Flue Gas Boilers Volume Temp at Content Steam Temp.℃ Temp at Inlet Outlet (m3/h) (oC) (g/m3) (t/hr) (oC) (oC)

HRSB of OBBF 89717 850±50 5.76 28.75 approx.250 380±50

HRSBs 1st Cycle 51599 25.41 of CFs 750±50 12.1-13.0 250 350±50 (3 Sets) 2nd Cycle 54889 9.44 HRSB of AF 12000 700 2x5 170 250±50 Stage 3 Heat 262307 272±10 14.4 HRSB of Exchanger Acid 158.8 180 Stage 4 Reaction Heat 231869 283±10 12.4 Exchanger

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A schematic flow chart of the heat recovery processes is provided below：

2. Flue Gas Dust Collection

Flue gases from OBBF and CFs would have dust contents in the range of 5 mg/m3 to 25 mg/m3 will then be treated by electrostatic precipitator (ESP) for dust removal. The flue gas from OBBS contains some dust, which is difficult to capture. The overall dust collection efficiency is expected to be 97.5%. The dust content of flue gas from ESPs is expected to be ≤ 0.5 g/m3.

The OBBF flue gas containing high arsenic content would further be treated by a sudden o o temperature drop process to cool the gas from some 350 C to 120 C to form As2O3 particulates, which would be collected in bag filter, as a by-product for cost recovery.

The amount of As2O3 to be recovered from the OBBF flue gas is expected to be 44.38 t/yr.

The treated OBBF and CF flue gases will then be sent to the sulfuric acid reaction process that follows.

A schematic flowchart of the dust collection and arsenic recovery process is presented below:

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3. Sulfuric Acid Reaction Process:

The inputs to the sulfuric acid reaction process is the flue gases from the OBBF 3 and the CFs with a total volume of 270,443.3 Nm /h, SO 2 concentration of 11.672% and dust content of 0.35 g/m3 and arsenic content of 36.02 kg/h. The acid reaction process is divided into purification section, conversion section and drying and absorption section. A schematic flowchart of the sulfuric acid reaction process is presented below.

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3.1 Purification Section

The temperature of the mixed OBBF and CF flue gases from Bag Filter Collector and ESP is approximately 200 ℃. When the flue gas enters Scrubber I, most of the smoke is retained by the film and cooled to adiabatic saturation; SO3 is converted to acid mists. In the gas cooling tower the gas will be further cooled so that the temperature of exit gas can reach the concentration of sulfuric acid product requirements. Flue gas from cooling tower flow through the Scrubber II for further purification, and then through the wet Electrostatic Precipitator I and the Electrostatic Precipitator II to remove acid mists, dusts and impurity. The exit gas would then flow into the drying and absorption section.

The acid, between the scrubbers and cooling tower, by liquid level control, follow the sequence by from dilute to concentrated, from back to front. The waste acid from the scrubber pump flows through desorption tower and leads into the settlement tank. Following filtration, the filtrate of the acid mud extracted from the bottom of the settlement tank, together with the overflow from the settlement, would be transferred into the middle slot and then to the waste acid treatment plant by waste acid transfer pump, for further treatment in order to reach the discharge standards. The filter cake is fed back to the melting system.

3.2 Conversion Section

The conversion process uses the double conversion technology that requires 3+1 catalyst layers as follows:

First conversion: the flue gas will be boosted by the SO2 blower, warmed up to 400 ℃ and then transported into the three catalyst-layers of the converter. Most SO2 in the flue gas is converted into SO3. The high-temperature flue gas from the three catalyst-layers is cooled and transported to the middle absorption tower, in which SO3 in flue gas will be sprayed with 98% sulfuric acid and converted to concentrated sulfuric acid.

Second conversion: When the gas is absorbed in the middle absorption tower, it will be warmed up to 420 ℃ and transported into the fourth catalyst-layer. The remained SO2 in flue gas is further converted to SO3 and the conversion rate can reach 99.8%. The flue gas from fourth catalyst-layer will be cooled and then transported into the final absorption 3 tower. The tail gas (containing SO2 775 mg/m ) will further be treated by the desulfurization.

3.2 Drying and Absorption Section

First flue gas from the wet electrostatic precipitator is led into the drying tower, dried by F2-6

93% sulfuric acid. The dry gas will be boosted and lead to conversion process. The converted flue gas from the First Conversion process is led into the middle absorption tower, in which SO3 is absorbed by 98% sulfuric acid. The exit gas is led into the Second Conversion process. The flue gas from the Second Conversion enters the Final Absorption Tower and absorbed by 98% sulfuric acid. The treated gas is discharged into the desulphurization processing.

4． Flue gas desulphurization processing

The exhaust from the sulfuric acid production process would contain SO2 up to 775 mg/m3. Exhaust gases from AF flue gas as well as smokes from other sources of the smelter plant would contain low SO2 concentration (0.02%). Both streams have already the met SO2 emission concentration standard. But for the purpose of total mass control and as part of the proposed subproject, the combined stream with a flow rate of 3 3 687,405 Nm /h and SO2 concentration of 700 mg/m would be treated by a desulfurization process to further remove total SO2 mass loading to the environment by another 90%.

The proposed desulfurization process employs the semi-dry limestone moving bed technology. Lime absorbs sulfur dioxide in the reaction of calcium sulfite, while it is a drying process for product at the same time. The final product is in a dry powder state. The design desulfurization efficiency is more than 90%. Through the treated offgas would 3 contain SO2 concentration less than 100 mg/m (68.73 kg/h), far below the applicable GB16297-1996 Class II Emission Limit of 960 mg/m3 (110 kg /h). The schematic of the desulfurization process is provided below.

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C. Summary of Energy Savings and Emission Reduction

With the implementation of the above waste heat recovery and emission reduction processes, the total energy savings are expected to reach 62,426 tce/yr. As indicated in the summary table below, this represents a recovery of over 45% of the overall energy inputs to the smelting plant. In addition, the electric power and steam generated through the waste heat recovery can also avoid CO2 emission reduction by 159,241 t/yr and SO2 emission by 318 t SO2/yr which would otherwise be caused by the coal fired power plant to generate the power. The above have not included the CO2 emission reduction resulted from the “Zero Carbon” technology applied in the main production process.

Further, with the SO2 removal processes, the SO2 emission can be reduced to 68.73 kg/h (544 t/yr in 330 production days per year), which is much lower than the applicable GB16297-1996 Class II Emission Limit of 960 mg/m3 and 110 kg /h (871 t/yr), representing a net emission reduction over the regulatory compliance limit by 327 t/yr.

Therefore the total calculated SO2 emission reduction of this subproject would be 646 t/yr.

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Table F2-1: Summary of Summary of Waste Heat Recovery at Lufang OBBF Smelter

Energy Inputs of the 1 million t/yr OBBF Multi-Metal Ore Smelter Total Energy Standard Total Actual Consumption Energy Coal Consumptio Items Units in Standard % Types Conversion n Coal Factor （t/yr） （tce/yr） Energy Inputs 1 Coal 0.803 t ce/t 2025 1626 1.2 2 Diesel 1.4446 t ce/t 2000 2889 2.1 3 Tar 1.3648 t ce/t 7485 10,216 7.5 Graphite 4 0.9711 t ce/t 700 680 0.5 Electrodes Solid 5 0.7143 t ce/t 2048 1463 1.1 Reductant Total power 6 0.35 kg ce/kW.h 341120 119,392 87.6 consumption Total 136,265 100.0 Waste Heat Recovery Low-pressure steam 0.1286 kg ce/kg 239263 30,769 49.3 Power generation mid-pressure 0.350 kg ce/kw.h 48980 17,143 27.5 Waste steam heat power (in MWh) generation Residual low pressure 0.1286 kg ce/kg 112860 14,514 23.3 steam Total 62,426 100.0 Overall Energy Recovery（%） (Recovered energy in tce/Total energy input in tce) 45.8 Source: Correspondence with China Enfei Engineering Technology Co., Ltd

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Appendix F3

Coal Washing ESCO Subproject by Shandong Mining Machinery Group Inc. (SMM)

Shandong Mining Machinery Group Inc. (SMM) was previously a state-owned enterprise established in 1955. It was transformed into a private limited liability company in 1999, and restructured into a group company thereafter. It is a leading coal mining equipment/system manufacturer in China and is among the top 100 companies in the Chinese coal industry. Its R&D center is a provincial level technical center and it also operates a R&D center in Beijing, which specializes in coal washing technologies.

The proposed project by SMM is an ESCO division within the SMM Group, which provides coal washing technology and equipment system and operation services to coal mines through a combination of lease-to-own and/or operation services schemes.

1. Description of Coal Washing Process

1.1 Conventional Coal Washing Process

Generally, a coal wasting plant consists of the following four systems.

1. Raw coal preparation system: The main coal washing equipments used in the system includes: shallow trough separator or vibrating screen jig, inclined wheel separator, vertical wheel separator etc. The tasks of the system are to remove large size coal waste and crush large size coal to washable grains, preparing for raw coal washing.

2. Primary washing system: currently, the primary washing system typically uses heavy medium cyclone or jig as primary washing equipment. The primary washing system is the core system in a coal washing plant. The design quality of the system will directly affect the clean coal quality, coal loss in coal waste and economic benefit.

3. Floatation system: The coal fines contained in the coal slime water from the primary washing process would be processed through a flotation system to recover fine clean coal. A typical floatation process is as follows:

Coal Slime Water  Floatation Machine Centrifuge  Fine Clean Coal Recovery

4. Coal slime water treatment system: During coal slime water treatment, coal slime water enters into the flotation system via a surge tank; following the floatation process that separate the clean coal fines from the coal slime water fed into flotation system, the flotation tailings enters the thickener for thickening. The overflow from the thickening pool may be recirculated back to the primary washing system for reuse. The thickened tailing sludge, mostly containing non-coal minerals including clay, purverized sandstone, inorganic sulfur ( in the form of FeS) ), would be dewatered by a press filter and the sludge cake would then be stored at a drying bed prior to disposal.

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Coal washing processes use water as the primary washing medium. Typically, 3-5m3 water is required to process 1 ton raw coal. With the increasing value of water resources, in modern coal washing plants closed-loop circulation of washing water is required. With wash water recirculation/reuse, net water consumption for processing each ton raw coal is typically in the range of 0.15 m3 to 0.25m3 or better. The daily water demand by a 20Mt/a coal washing plant would be in the range of 6000 m3 to 10,000m3.

The products from the process would include: (1) Clean coal; (2) Fine clean coal; and (3) Middling

The wastes produced from the coal washing process would include: (1) Coal waste; and (2) Flotation tailings ( or coal slime)

The coal wastes from the primary coal washing system (heavy medium separation system) can be used for power generation or making bricks and cement according to the heating value of coal waste. Usually about one-third of coal waste from the primary coal washing system can be used for power generation. Desulfurization technology at waste coal power plant has been mature in China, such as the circulated fluidized bed (CFB) combustion technology with inside stove desulfurization, which can remove more than 80% of sulfur. When coal waste is used for brick making, the heat value of waste coal should be lower than 800kcal/kg, as few limestone is mixed with coal waste, the sulfur in the coal waste will react with limestone, so as to capture the sulfur in the brick. Therefore use of coal waste will not have remarkable impact on the environment. In the economically developed provinces, most coal waste is reused for the above applications. In underdeveloped provinces, most coal waste from primary coal washing system is discharged to the designated stockpile for concentrated treatment.

The coal wastes from raw coal preparation system has very low heating value (less than 300kcal/kg) will be stockpiled at designated site together with coal waste from coal mining. The on-site coal waste stockpile needs to be stabilized to prevent coal waste from spontaneous combustion. The typical stabilization measure is to tightly cover the coal waste with soil layer by layer, so as to prevent air from entering into the coal waste stockpile. Regarding the wastewater discharged from coal waste stockpile, limestone is used to neutralize the waste water. The coal waste stockpile will be eventually covered by top soil, planting bushes or grass on the top soil upon closure following the requirements of the Solid Waste Pollution Prevention Law of the People’s Republic of China. The coal waste can also be used for land reclamation, such as filling subsidence area in coal mining area caused by coal mining.

The flotation tailings, also called coal slime, usually has high moisture but medium heating value (approximately 3500 kcal/kg to 4000 kcal/kg), which can be used as fuel. In China, the coal slime is mainly used for power generation. The coal slime is often mixed with waste coal, middlings and low grade raw coal to meet a certain heat value required for CFB boilers. The inside stove desulfurization technology is widely mature amongst CFB boilers at power plants in China.

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1.2 SMM Coal Washing Systems

The schematic of a typical SMM coal washing plant is presented below. As discussed below, the SMM system incorporates advanced technologies that are owned by SMM as well as other advanced technologies from leading vendors in the country.

The SMM coal washing plant adopts modern coal washing technology; heavy medium coal washing technology will be used at the primary washing system. Heavy medium coal washing separates coal from coal waste by density and uses liquid agent as medium. The clean coal with density less than the liquid floats while the coal waste and middling with density greater than the liquid settle. To compare with conventional primary coal washing process by cyclone, the technology features multiple advantages, including stable clean coal quality, less coal loss and high clean coal recovery.

A key technical advance of the SMM coal washing plant is SMM’s proprietary flotation technology.

A conventional flotation process would include:

Coal Slime Water  Conventional Floatation Machine Centrifuge  Fine Clean Coal

The SMM proprietary flotation system consists of the following:

Coal Slime Water → Coal Surface Improvement Device → Micro-bubble Flotation Machine → Press Filter → Fine Clean Coal

This proprietary flotation system can effectively solve the technical issues associated with poor quality (high clay contents, high sulfur contents) and low yield of fine clean coal.

The above flotation technology is developed by Beijing Sankuangtong Technology Co., owned by Shandong Mining Machinery Group. Beijing Sankuangtong Technology Co. is a high-tech enterprise specialized in researching and developing coal washing related technologies and equipments. The company has developed large and complete coal washing equipment and complete equipment especially for fine coal recovery and dewatering, with their technical performance reaching the world class level. Currently, the biggest issue that coal preparation plants in China are facing is the effective treatment of coal slime water. The coal slime with size less than 0.5mm is difficult to separate due to its large ratio of surface area to mass. With the increase of machinery mining and deteriorating geological condition of coal resources, the proportion of slime in raw coals can reach 30% or higher. Meanwhile, the washability of raw coals are getting poorer. Therefore, effective treatment of coal slime is getting more and more important.

The advanced SMM fine coal processing system can significantly increase clean coal recovery, while reducing energy consumption, investment cost and operating costs. Based on our previous studies endorsed by leading expert panels in China, the use of the advanced SMM fine coal recovery technology can increase the fine clean coal recovery by 5% and reduce flotation medium consumption by more than 70%, reaching the world advanced level. Assuming fine coal accounts for over 5% in raw coal, the overall increased clean coal recovery from fine coal would be 0.265% of clean coal. For the total processing capacity of 20 Mt coal or clean coal production F3-3

capacity of 16 Mt per year proposed for this subproject, the increased fine coal recovery alone would be 53,000t/year with a market value of CNY38,750,000/year (assuming a price of CNY750 Yuan/t for fine clean coal). The incremental value of the increased clean fine coal recovery alone would be over 10% of the installation costs for the proposed coal washing systems of 20 Mt/yr capacity.

As highlighted in the schematic below, approximately 80% of the equipments used in a typical SMM coal washing plant would be manufactured by SMM. Aside from those technologies of SMM that leads the industry in the country, the SMM coal washing system would also incorporate other advanced technologies/equipments from other leading vendors in the country, including the monitoring and control system from China University of Mining Technology, which has been used in more than 50 coal preparation plants in China, and media pumps from Shijiazhuang Industrial Pump Factory, which is the leading media pump manufacturer in the country, and magnetic separation machine by Yinkou Magnetic Separation Equipment Factory.

2. Business Model

2.1 Market Opportunities and Barriers

Coal washing is a highly effective energy saving measure from the source (i.e. at coal mines). Coal washing reduces the transportation energy cost that would otherwise be consumed by waste coal, reduce SO2 emission by removing inorganic sulfur content associated with raw coal, and improve the combustion efficiency on the user. As an effective energy saving and emission reduction process, coal washing is strongly encouraged by national industrial policy. In 2007, NDRC set the target to increase raw coal washing rate from 32% in 2005 to 50% by the end of 2010. There is a huge demand in coal washing capacity. Moreover, as discussed above, using SMM proprietary technology, the recovered fine coal alone will pay off the installation of coal washing equipments in 10 years.

Despite the apparent benefit and high market demand, there are difficulties for coal mining companies to develop coal washing projects. First, the equipments and technologies of coal washings are complicated (specially the flotation system of fine coal). The maturity and reliability of equipments from different manufactures can differ greatly. Medium and small sized coal mining facilities may be lack of competent personnel with adequate knowledge and capability of system management. Further, although the coal washing projects have very good return on investment, comparing to coal mining, it requires higher capital investment and longer payback period, resulting in relatively low return on investment (ROI). In the past years, as small-to- medium coal mines are being shut down because tightened safety requirements, the market demand for coal outpaces the supply capacity of the remaining mid-to-large size coal mines. As a result, the coal price has been increasing steadily in China and the return on coal mining can be as high as 50% in the current market, which make the investment return on coal washing facility 20~30% relatively unattractive.

However, in comparison with other manufacturing sectors, a 20-30% investment return is still a remunerative business. The current market conditions hence open the door for coal washing equipment suppliers to expand in the coal washing market if provided with right financial and technical strategy.

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2.2 Proposed Business Model

Energy Service Company (ESCO) is a professional business established based on energy performance contracting (EPC). Services provided by ESCO may be contracted through an energy services agreement with client who is going to install retrofit measures to improve energy efficiency. ESCOs provide a broad range of comprehensive energy solutions including energy audit, feasibility study, project design, project financing, procurement of equipments and materials, construction, personnel training, energy saving monitoring, operation, maintenance and management of retrofitted/installed energy systems. Through the agreement, the ESCO will profit from either (a) sharing the energy saving with client after implementation of the services, or (b) payment by the client for offering guarantee of certain energy savings or taking over the overall energy bills over a contract term.

General speaking, ESCO providers can fall under the following three categories: technology (equipment) driving, market oriented and financial oriented. Energy equipment manufacturers, public energy suppliers and energy investors can all be potential ESCO providers.

SMM proposes an innovative business model of Energy Service Company (ESCO) to participate in targeted coal washing projects with a combination of technical and financial drives. The proposed ESCO model is designed to tap into the lucrative coal washing business by offering a combination of lease-to-own financing and operational serves (LTOO) to overcome both financial and technical barriers. Under the LTOO model, a complete coal washing equipment system will be supplied with financial support and performance guarantee while the offer for operation outsourcing would address coal mine owners’ concern over lack of operation and management team. Once the equipment system has proven its reliability, quality and efficiency through a pre-determined period of operation (typically 3-5 years), the ownership of the equipment can then be transferred to the coal mine company. Through the duration of operation, a local operation team will take shape to allow for a smooth handover to the project owner.

A key to the success of an ESCO project is the energy saving amount can be quantified and verified by through simple and effective monitoring measures. As it is a complex process to calculate the resulted energy saving through coal washing against the baseline which is highly dependent on the quality of raw coal, the proposed SMM ESCO would not use the energy saving guarantee payment mode. Rather, the energy saving profit share mode will be adopted in this proposed project: Under the LTOO model supply the equipment under a lease-to-own scheme and provide management and/or operation personnel to a varied extent to look after the daily operation of coal washing plant; on the premise that the agreed coal washing efficiency and fine coal recovery rate is achieved, SMM will be paid for a reasonable processing fee according to the total coal wash amount, as the profit for achieved energy saving. Where to client does not require operation service, the agreement can be a simple equipment lease-to- own scheme with vendor technical supports.

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2.3 Project Management

2.3.1 Project Cycle

SMM will provide the following seven integrated services under the ESCO-LTOO scheme, including:

 Consulting and identification: By conducting test on the system of coal mine and proposed coal washing plant, SMM will analyze the characteristics of raw coal preparation, and the parameters of the proposed coal washing equipments, operation and management condition, analyze the problems of system and equipments, to provide recommendation and complete solution for coal mine and coal washing company;

 Feasibility study and proposal demonstration: based on the advanced fine coal washing technology and equipment of SMM, with other associated advanced equipments from other facilities, SMM will provide an advanced, appropriate, economic and feasible retrofit proposal with economic assessment and technical demonstration, according the different requirements of raw coal and washing processes, equipment conditions;

 Equipment selection and procurement: SMM will provide complete set of fine coal preparation equipments and associated imported or domestic equipments from other facilities according to client’s requirement;

 Leasing/financing and fund management: the complete set of coal washing equipment and purchase other associated equipments will be acquired on financing lease or operation lease, funded by SMM, offered to coal washing client (coal mine) for use as financing support;

 Engineering design, installation and commissioning: SMM will provide a whole set of services of design, construction, installation and commissioning;

 Operation outsourcing service: if requested, SMM will build a whole operation team to take over the operation and maintenance of the system. SMM will be paid for a reasonable service fee based. Upon lease expiration, SMM will handover of the ownership of the equipment to the coal mine; and

 Personnel training: SMM will provide technical training for the management personnel and operators of the coal washing system to help ensure a smooth transfer of operation to the coal mine.

2.3.2 Commercial Terms

Guarantee of coal washing efficiency and fine coal recycling rate: SMM shall ensure the coal washing efficiency and fine coal recycling rate, based on the characteristics of raw coal preparation and design proposal of the complete set of coal washing equipments.

Equipment leasing cost: the purchase and construction of complete set equipment will be funded by SMM. The equipment will be leased to the owner of coal washing company at an

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agreed rental rate (cost+risk premium+rental profit) for a period up to 6.5 years (including 1.5 years of construction period).

Operation service cost: SMM will charge for operation service fees according to the amount of raw coal washed, under the premise that the agreed coal washing efficiency and fine coal recovery rate are achieved. The costs and expenses incurred related to coal washing will be covered under SMM service fees. The operation service fee is assumed to be approximately CNY 33 Yuan/t. With estimated operation costs and expenses of approximately CNY 26 Yuan/t, the gross profit would be approximately CNY 8 Yuan/t. This profit would be on top of the rental profit.

Ownership of the coal washing equipments: the complete set equipments will be transferred to the owner of coal washing company when the lease contract of 6.5 years expires. If the coal washing system still needs follow-up maintenance and technology supports or software upgrades from SMM, further negotiation between two parties will be need.

2.3.3 Risk Management

In order to promote the development of the technology and equipment of energy-saving & emission reduction in coal industry, SMM has developed Energy-saving & Emission Reduction Service Center (the Center). The Center consists of Project Management Department, ADB Loan Management Department, and Project Evaluation Committee and the Risk Management Committee in charge of project promotion, technical services and project evaluation, project review, implementation management, reimbursement, loan repayment and so on.

SMM has more than 40 years history in coal machinery industry, with thousands of clients. There are more than 80 clients who have used the complete set of coal washing equipments from SMM. SMM has good understanding of the demand of its clients and has sufficient experience and ability to operate with some of low risk clients under an ESCO approach.

SMM will choose coal enterprises with solid reputation (enterprise or other economic organizations approved by Business Administration Department or competent authority) to promote energy-saving & emission reduction services. Appropriate coal washing process will be designed according to the different requirement of clients and coal quality, which will be negotiated by both sides. Project Review Committee and the Risk Management Committee will review the project of the candidate plant (including: project feasibility study report, project EIA report, site selection, financing sources and availability of funds, etc.), and carry out the project assessment, project acceptance and so on. SMM will sign a cooperation agreement and a Technical Services Agreement with the coal washing plant after the project is approved. Both sides will reach an agreement on how to charge for rent and operating fee.

Project Management Department is responsible for the project implementation, to ensure that projects can be implemented on schedule. After the completion of the coal washing plant installation, SMM will designate a team of management personnel and operators for the project operation, and carry out regular follow-up survey of the operating conditions, the use of fund and so on. After the contractual principal and interest is repaid in full, the equipment will be handover to the owner of the plant.

All principal and interest shall be paid in accordance with the contract. Loan shall be repaid within two years after the construction period, which is the third year, and repaid off in the F3-7

seventh year. There are two parts for the repayment, one is the principal repayment, which shall be repaid by level yearly payments from the third year with repayment period of 3-5 years; the other part is the interest repayment. The leasing income shall be able to cover the payment of interest, other financial charges, and other costs. According to the leasing provisions, in addition to project evaluation, there shall also be collateral, security and other risk prevention measures to ensure that the collection of payment from lessee and the loan repayment is on schedule.

SMM will not be responsible for the infrastructure of the candidate coal washing plants and limits its roles to equipment supply, installation and operation. As such, SMM’s project selection under this ESCO would be limited to only those projects of which the coal mine owners have secured financing for the civil works/infrastructures and have acquired proper environmental impact assessment (EIA) and proper EIA approval.

Most coal wastes from the coal washing plant would be reused for making bricks and cement for sulfur fixation or used in power plants equipped with proper desulfurization technologies. The coal waste with too low a heat value to reuse may be used to fill subsidence area in coal mining area caused by coal mining. SMM will review the EIA before engaging in an equipment/service supply contract to ensure that the EIA report contains proper measures regarding coal waste handling, disposal/reuse as it is properly approved by the environmental protection bureau (EPB).

3.0 Summary of Energy Savings and Emission Reduction

The initial targeted candidates include five coal washing plants distributed in Shanxi (2), Anhui (1) and Shandong (2) provinces with a total annual coal washing capacity of 20 million tons per year and clean coal production capacity of 16.8 million tons per year, requiring a total equipment investment of CNY 38,356 million.

Energy savings from the subproject mainly include the improved energy efficiency of coal fired boilers due to use of clean coal, recovery of fine coal and avoided transportation of waste coal by railway. For a total processing capacity of 20Mt/yr, the total direct and indirect energy savings would be approximately 804,000 tce/yr, resulting in CO2 emission reduction by

1,968,658 tCO2. However, as coal washing of 20Mt would consume 120 million KWh, electricity, result in indirect CO2 emission of 107,232t/yr. The net CO2 emission reduction of the SMM coal washing ESCO would be 1,861,426 t CO2/yr.

Coal washing can remove 60-80% inorganic sulfur in raw coal. For a total coal washing capacity of 20Mt/yr, the total removed organic sulfur is estimated to be 72,000 t/yr. Assuming average sulfur removal efficiency of flue gas from coal combustion at various boilers is 85%, if the above inorganic sulfur has not be removed by coal washing, it would result in 21,600 t SO2 emission.

However, electricity consumption at coal washing plants will result in indirect SO2 emission by up to 498 t. Therefore, the resulting net SO2 emission reduction is calculated to be 21,102 t/yr.

A breakdown of estimated energy savings and CO2/SO2 emission reduction amongst the five candidate plants is provided below.

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Table F3-1: Summary of Initial Coal Washing Candidate Projects

SO CO Design Equipment 2 2 Energy Saving Emission Emission Project Name Capacity Investment Reduction Reduction (Mt/yr） (Million CNY) (,000 tce/year) (t/yr) (,000 t/yr)

DongDa Coal Mine Coal Washing Plant in 8.0 148.56 321,600 8,441 744,571 Jincheng

Yangcheng Coal Washing Plant of Jining Mining 2.4 50.00 96,480 2,532 223,371 Group

Guotun Coal Washing 2.6 104,520 2,743 241,985 Plant of LuNeng Group 53.00

Feicheng Liangbaoshi Coal Mine Coal Wash 6.0 110.00 241,200 6,331 558,428 Plant

Jingfang Coal Mine Coal Wash Plant in Changzhi 1.0 22.00 40,200 1,055 93,071 County, Shanxi

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APPENDIX G: DETAILED COST ESTIMATES

Table G1: Detailed Cost Estimates for Three Initial Subprojects

CNY $ % of Total Item '000 '000 Cost A. Base Costs 1,260,462 185,362 88.5 Golden Yimeng 415,810 61,149 29.2 Lufang 432,492 63,602 30.4 SMM 412,160 60,612 28.9

A1 Working Capital 39,680 5,835 2.8 Golden Yimeng 1,530 225 0.1 Lufang 15,790 2,322 1.1 SMM 22,360 3,288 1.6

B. Contingencies 66,830 9,828 4.7 1 Physical contingency 25,650 3,772 1.8 2 Price contingency 41,181 6,056 2.9

C. Financing Charges During Development 57,622 8,474 4.0 1 Interest during Development 56,970 8,378 4.0 2 Commitment and front-end fees 652 96 0.0

Total Investment (A+A1+B+C) 1,424,595 209,499 100.0 Golden Yimeng 442,914 65,134 31.1 Lufang 521,550 76,699 36.6 SMM 460,131 67,666 32.3 Notes: The base costs include taxes and duties estimated at $15.11 million, including $9.74 million for ADB financed components. All costs are estimated in end of 2009 prices. Sources: Subproject feasibility study reports and ADB estimates

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Table G2: Detailed Investment Cost Estimates for Golden Yimeng Total Civil Works Equipment Installation Devices Other Total % of Total Item CNY '000 $'000 Cost A. Base Costs 415,810 64,120 204,080 75,590 30,680 41,340 61,149 93.88 1 Biogas Capture and Utilization 132,200 28,310 49,160 45,530 9,200 - 19,441 29.85 2 Waste Heat Recovery and Solar Thermal 75,260 10,150 47,410 8,000 9,700 - 11,068 16.99 3 Anaerobic Sludge Treatment 32,110 14,500 10,900 4,810 1,900 - 4,722 7.25 Energy Efficiency Improvement in 4 Production 100,240 2,850 79,410 13,100 4,880 - 14,741 22.63 5 Capacity Building for EE&ER 8,900 1,350 1,800 750 5,000 - 1,309 2.01 6 Support Facilities 25,760 6,960 15,400 3,400 - - 3,788 5.82 7 Feasibility Study, Design and Supervision 35,180 35,180 5,174 7.94 8 Technology Transfer Fee 2,000 2,000 294 0.45 9 Other Expenses 4,160 4,160 612 0.94

B. Contingencies 8,050 8,050 1,184 1.82 1 Physical contingency 4,025 4,025 592 0.91 2 Price contingency 4,025 4,025 592 0.91

C. Financing Charges During Development 17,523 17,523 2,577 3.96 1 Interest during Development 17,360 17,360 2,553 3.92 2 Commitment and front-end fees 163 163 24 0.04

D. Total Working Capital 1,530 1,530 225 0.35 Total Project Cost (A+B+C+D) 442,914 64,120 204,080 75,590 30,680 68,444 65,134 100.00 Source: Subproject Feasibility Studies and Consultant Estimates All costs are estimated in end-2009 prices.

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Table G2: Detailed Investment Cost Estimates for Lufang Total Civil Works Equipment Installation Devices Other Total % of Total Item CNY '000 $'000 Cost A. Base Costs 432,492 46,962 240,503 96,593 3,109 45,326 63,602 82.9 1 Waste Ore Treatment 103,677 16,652 66,772 20,254 - - 15,247 19.9 2 Flue Gas Desurfication 223,790 23,386 134,585 65,819 - - 32,910 42.9 3 Waste Heat Recovery for Power Generation 56,591 6,924 39,146 10,520 - - 8,322 10.9 4 Project Design, Supervision and Other Expenses 48,435 - - - 3,109 45,326 7,123 9.3 - B. Contingencies 58,780 58,780 8,644 11.3 1 Physical contingency 21,625 21,625 3,180 4.1 2 Price contingency 37,155 37,155 5,464 7.1

C. Financing Charges During Development 14,488 - - - - 14,488 2,131 2.8 1 Interest during Development 14,130 14,130 2,078 2.7 2 Commitment and front-end fees 358 358 53 0.1

D. Total Working Capital 15,790 15,790 2,322 3.0

Total Project Cost (A+B+C+D) 521,550 46,962 240,503 96,593 3,109 134,384 76,699 100.0 Source: Subproject Feasibility Studies and Consultant Estimates All costs are estimated in end-2009 prices.

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Table G3: Detailed Investment Cost Estimates for SMM Total Civil Works Equipment Installation Devices Other Total % of Total Item CNY '000 $'000 Cost A. Base Costs 412,160 373,971 5,753 - 32,436 60,612 89.6 1 Energy Service Investment 383,560 - 373,971 5,753 - 3,836 56,406 83.4 a Jincheng Dongda 148,560 144,846 2,228 1,486 21,847 32.3 b Jining Yangcheng 50,000 48,750 750 500 7,353 10.9 c Luneng Guotun 53,000 51,675 795 530 7,794 11.5 d Feicheng Liangbaoshi 110,000 107,250 1,650 1,100 16,176 23.9 e Changzhi Jinfan 22,000 21,450 330 220 3,235 4.8 2 ESCO System Development/R&D 28,600 28,600 4,206 6.2 3 Project Design, Supervision and Other Expenses

B. Contingencies - - - - 1 Physical contingency - - - - 2 Price contingency - - - -

C. Financing Charges During Development 25,611 - - - - 25,611 3,766 5.6 1 Interest during Development 25,480 25,480 3,747 5.5 2 Commitment and front-end fees 131 131 19 0.0

D. Total Working Capital 22,360 22,360 3,288 4.9

Total Project Cost (A+B+C+D) 460,131 - 373,971 5,753 - 80,406 67,666 100.0 Source: Subproject Feasibility Studies and Consultant Estimates All costs are estimated in end-2009 prices.

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APPENDIX H: SUBPROJECT SELECTION CRITERIA

A. Project Features

The Shandong Energy Efficiency and Emission Reduction Project (the Project) focuses on financing energy efficiency (EE) and emission reduction (ER) subprojects, developing energy service companies (ESCOs), enhancing institutional capacities for cleaner production, controlling of industrial pollution, and contributing to overall environmental management in Shandong Province of the People's Republic of China (PRC). The Project will adopt the financial intermediation loan (FIL) modality of Asian Development Bank (ADB) to scale up investments in EE&ER through revolving uses of funds, mobilizing domestic knowledge and financial resources for co-financing and replication, reducing transaction complexities and costs, and strengthening impact monitoring and evaluation.

All subprojects must strictly follow the applicable provincial and national procedures, including the approvals on the environmental impact assessment (EIA) and the feasibility study. The Project Steering Committee will hold the authority and responsibility for approving future subprojects to be financed in various batches by revolving uses of funds under the Project. Any subprojects with debt components exceeding the free limit of $15 million must obtain pre-approval from ADB.

B. Selection Procedure

The first batch of subprojects has been assessed under an Asian Development Bank (ADB) project preparatory technical assistance. For subprojects to be included in the subsequent batches, the applicable national and provincial laws, regulations, and procedures will apply in selecting the subprojects. Procedures to select subsequent subprojects will be finalized between all concerned agencies of People’s Republic of China prior to first disbursement.

All subprojects must meet the technical, financial, economic, environmental, and social criteria as presented below. These criteria will ensure that the selected subprojects lead and demonstrate energy efficiency and emission reduction work in Shandong Province with advance technology, prompt returns, and presents substantial benefits to the economy, society, and environment. The project management office may approve, on special occasions, certain subprojects that meet most but not all the criteria, contingent on ADB's review and formal endorsement in writing.

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C. Subproject Technical Criteria

All subprojects must use proven high energy efficiency technologies. The energy efficiency and emission reduction of greenhouse gases and other pollutants mainly carbon dioxide, sulfur dioxide, nitrogen oxide and/or total particulate matter results shall be reliable, measurable and verifiable.

Funds shall not be used for expansion of production capacities or extension of the uses of old and inefficient equipment. Any investment that improves energy efficiency and emission reduction by at least 10% from the base case should be considered under this project.

D. Subproject Financial Criteria

All subprojects must be financially viable. In particular:

(i) The estimated subproject investment and operations costs, as well as cash in-flows, must be clearly presented and must be reasonable; (ii) The financial internal rate of return shall be greater than the weighted average cost of capital; (iii) The payback period shall match the repayment period; (iv) The average debt–service coverage ratio shall be at least 1.2; and (v) The financial internal rate of return must be robust under various sensitivity scenarios.

E. Subborrower Financial Criteria

All subborrowers must be financially creditworthy and does not have a poor credit record, as recorded in the People’s Bank of China credit history database. As well, the subborrower should meet the following financial performance indicators:1

(i) total debt/equity ratio not more than 75/25; (ii) overall debt service ratio 1.2; and (iii) overall current ratio at least 1.1.

1 In the event a subborrower does not meet these indicators but the projected energy savings are considerably higher than average, it should provide acceptable collateral and/or loan guarantee for the amount of the subloan or as agreed with the financial intermediary.

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The subborrowers must contribute a minimum of 25% of the total subproject investment cost as counterpart financing.

F. Subproject Economic Criteria

For all the proposed subprojects, the total economic benefits must exceed the total economic costs. The economic internal rate of return of the subproject must be greater than the discount rate of 12%, and must be viable under adverse sensitivity scenarios.

The subborrowers shall commit to enhance capacities in project planning, financing, implementing and monitoring during the subproject preparation and implementation periods.

G. Subproject Social and Environmental Safeguards Criteria

(i) The subprojects must not involve any land acquisition or housing demolition. The subproject proposal will be screened through an involuntary resettlement impact screening checklist (as Appendix 4 of ESMS). The checklist will be submitted to ADB for approval to confirm that no land acquisition or house demolition will be required;

(ii) The subprojects must not have adverse impacts on ethnic minorities. The subproject proposal will be screened through an ethnic minorities impact screening checklist (as Appendix 5 of ESMS). The checklist will be submitted to ADB for approval to confirm that there are no adverse impacts on ethnic minorities;

(iii) The subprojects must not be located in any designated environmental protection zone;

(iv) Each subproject must be designed, constructed, and operated in accordance with relevant national and provincial social and environmental laws and regulations;

(v) Subproject must meet requirements of the ESMS developed for the loan project; and

(vi) Initial Poverty and Social Assessment and Summary of Poverty Reduction and Social Strategy (as Appendix 6 of ESMS) shall be prepared for all subprojects.

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APPENDIX I: MODIFIED FIL MODALITY FOR SHANDONG ENERGY EFFICIENCY AND EMISSION REDUCTION PROJECT

A. Rationale and Design of the Modified FIL Modality

The existing industrial energy efficiency financing mechanisms in Shandong and the PRC have mainly benefited small projects, primarily through energy service company (ESCO) involvement. While the ESCO concept has been operative in PRC since 1998 its implementation was rather slow and limited to small-scale industrial energy efficiency improvements, e.g., retrofitting of air-conditioners, lighting, pumps and motors. Accordingly, there is a large financing gap for medium- and large-sized1 energy conservation projects that involves whole or part of an industrial manufacturing process for a particular industry. There are three key barriers that have impeded the investment: (i) lack of familiarity with the range of available energy conservation technologies, combined with the enterprise’s perception of causing production interruptions/loss of revenues; (ii) lack of additional revenue generation by energy efficiency projects making it difficult for banks to assess the cash flow benefits and forgo collaterals for significant lending; and (iii) lack of capacity for proper evaluation and consequent risk assignments for energy conservation investments by domestic commercial banks. Limited market-based incentive mechanisms to reward investors in reducing emissions through energy efficiency also discourage investors. Due to smaller emission reductions per transaction, large and scattered investments, multiple technologies and processes, the risks are high in seeking clean development mechanism registration for the projects. Preferred loans from the government and IFI are hence in need for EE&ER projects despite the typically high investment return on such projects.

A Modified FIL modality is hence proposed with simplified subproject appraisal and strengthened implementation supervision to give SPG the needed flexibility to meet the short turnaround time required for EE&ER activities. In particular, the Modified FIL modality was chosen to (i) allow multiple rollover of ADB loan amount, thus, providing larger investments for energy efficiency over the loan tenor, (ii) build knowledge and capacity of provincial government and domestic financial institution in evaluation and risk assignments on energy efficiency transactions, (iii) reduce transaction

1 The size of an energy efficiency investment is defined by the estimated investment cost of a single energy efficiency technology intervention. The targeted energy efficiency investments of the proposed project range from $10 million and above, compared with small-sized investments in the range of $1 to $5 million or less. The size of an industrial enterprise is defined by its annual revenues. According to the China State Statistical Bureau (2008 Guidelines), enterprises are defined as medium-sized if their annual revenues are in the range of CNY30 million to CNY300 million (approximately $4.4 million to $40 million), and large-sized if in excess of CNY300 million.

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complexities and costs due to familiarity and experience gained by both the PMO and financial intermediary from the initial subprojects, and (iv) enhance governance and improve safeguard compliance for energy efficiency investments beyond the first batch of subprojects.

In addition, the design of the Shandong EE&ER FIL has taken into account a number of other factors, as outlined below:

 Where the investment decision is made to proceed with an EE&ER subproject, the available project preparation time for EE&ER is usually short as some of the project owners may have already been under regulatory pressure from the local government to resolve outstanding emission or energy efficiency issues. As well, EE&ER subprojects typically do not require land acquisition and settlement or extensive government approval. For example, most retrofit projects may require only simplified EIA form, if at all, to get approved in a few weeks. (In comparison, the regulatory approval process a new industrial construction project may take one year, if not longer.) The implementation period of EE&ER subprojects is usually short as they typically employ matured technologies and equipments. For example, a waste heat recovery and generation system can be finished in a few months;

 The return on EE&ER subprojects is typically immediate as they require no marketing, no sales, after commissioning. The investment payback periods of EE&ER subprojects are usually short (generally less than 4-6 years. Including a typical construction period of 0.5 year to 1 year, the required loan tenure for EE&ER subproject is typically 5 to 7 years, if not shorter;

 Most EE&ER projects are small investments. The total investments are usually less than $20 million and the size of subloan from the ADB portion may be less than $10 million, which are much smaller than traditional ADB loans for infrastructural and environment projects. However, the initial three subprojects under this FIL are exceptionally large, with the largest proposed ADB loan amount reaching $40 million. Largely due to the full support of SPG to this ADB Project, all three initial subprojects selected and mobilized by the local governments are the leaders in their individual sectors in Shandong province, and leading players in the country. In part because of the large scales of the first batch subprojects, the local governments are willing to extend the guaranty required for the ADB loans to the private enterprises, which is typically a barrier for IFIs to provide preferred loans to private enterprises. The average size of subsequent batches of sub-loans can be expected to be smaller and is likely to be less than $10 million, if not much smaller;

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 Most potential EE&ER subprojects are expected to be located in relatively remote parts of Shandong because they tend to be associated with energy intensive (and typically high pollution) sectors. Outside of major cities, direct services by IFIs to small projects will be highly costly and inefficient. Given expected numerous small subprojects scattering amongst relatively remote areas, ADB’s direct supervision of procurement, disbursement, and subproject approval will not be efficient or effective under a standard ADB FIL modality.

A detailed comparison between a standard ADB Loan Modality and the proposed Modified FIL Modality is provided below to help explain the rationale of usage of Modified FIL Modality for the Shandong EE&ER project.

Item Project Loan FIL Modified FIL

1. ADB loan from ordinary capital reserves (OCR)

Interest rate LIBOR linked

Tenure 24 years 15 years

Commitment charges 0.15% of undisbursed amount

Sub-loan terms The sub-loan Same as ADB Within the allowable band of the to EAs interest rate loan terms 6-month interest rate set by the People's Bank of China for lending by commercial banks

The sub-loan Same as ADB To be determined Can be set tenure loan terms by FI uniformly by EA, such as at 6 years

Exchange rate Usually borne by Borne by FI Managed by risk project EA/SFB

2. Project preparation

Technical review of feasibility First-batch studies of subprojects subprojects

prepared by Economic analysis of subprojects ADB PPTA team;

subsequent subloans by PMO after ADB During PPTA After ADB loan loan approval

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Item Project Loan FIL Modified FIL implementation approval, by FI Financial review of subprojects Pilot subprojects by consultants prepared by Financial projections and key and ADB Project ADB PPTA financial indicators of EAs Team team; subsequent subloans by FI after ADB loan approval

Environmental assessment， Environment Environment examination and resettlement plan Assessment and Assessment preparation Review and Review Framework agreed Framework during PPTA agreed during implementation ; PPTA implementation; Categorization of subprojects done Categorization by FI accordingly of subprojects after ADB loan done approval accordingly after ADB loan approval by PMO

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Item Project Loan FIL Modified FIL

3. Approval for subprojects to be All subprojects to Approval by the Approval by the eligible for utilizing the ADB loan be identified Steering Group Steering Group before loan except when the except when the

negotiations and loan amount is loan amount is Board approval above a “free limit”; above a “free ADB would do post limit”; ADB Inclusion of a approval review in would do post new subproject most cases; approval review (not included at prior ADB review in most cases; the time of loan would be required priori ADB negotiations) will for subloan amount review would be require prior exceeding the “free required for approval by ADB limit”. subloan amount exceeding the “free limit”. FI reserves the right to reject subprojects if the sub-borrower’s financial health is questionable.

4. Procurement

Preparation of Procurement Plan During PPTA implementation by consultants and ADB Project Team

Package list After ADB loan After ADB loan approval, by PMO approval, by PMO

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Item Project Loan FIL Modified FIL

Procurement method and threshold ICB for goods Threshold apply A procurement package of over only when manual to be

$1 million centralized prepared by the procurement is PMO and NCB for goods done by PMO; approved by packages ADB prior to between otherwise, undertaking any $100,000 and $1 procurement by procurement million IAs using activities. competitive procedures

Procurement notice Special notice for To be advertised in local newspaper all ADB funded by the IAs.

packages to be published in ADBBO

Prior ADB review of bidding Prior ADB review Reviewed by FI; Normally document, bid evaluation report and required for all ADB reserves the reviewed by contract award bidding right to review PMO; ADB documents for procurement. reserves the ICB packages right to review

procurement. Prior ADB review of the bidding document for first

NCB package only

All bid evaluation reports and negotiated contracts to be approved by ADB

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Item Project Loan FIL Modified FIL

5. Disbursement of ADB loan Direct, statement Following approval Following of expenditure, or of subprojects by approval of

as the Steering subproject by reimbursement; Group, ADB loan the Steering invoices for to be disbursed to Group, ADB goods included in the FI; thereafter, loan to be approved the FI will disburse disbursed and packages to be to contractors; then transferred submitted to ADB invoices not to be to the trust sent to ADB account within 5

working days; thereafter, the funds will be disbursed to sub-borrowers as approved by the PMO; invoices not to be sent to ADB

6. Supervision of subproject By PMO with By FI with quarterly By PMO with implementation quarterly report reports submitted quarterly reports submission to to ADB submitted to

ADB ADB ADB loan review ADB loan review missions fielded till ADB loan review missions fielded full loan amount missions fielded till the full loan has been till full loan amount has been disbursed, amount has disbursed thereafter only FI been disbursed, responsible for thereafter only supervision PMO responsible for supervision

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Item Project Loan FIL Modified FIL

7. Eligibility criteria for subprojects Not applicable, During PPTA During PPTA funded from sub-loan repayments ADB loan has to implementation, implementation, be repaid once eligibility criteria eligibility criteria

the IAs repay the prepared and prepared and sub-loans agreed between agreed between EA and ADB, EA and ADB,

thereafter FI to thereafter PMO determine if the IA to determine if meets the eligibility the IA meets the criteria; eligibility criteria;

ADB review ADB review needed when the needed when sub-loan amount is the sub-loan above “free limit” amount is above “free limit”

IA = Implementation Agency (e.g. subborrower); EA = Execution Agency (i.e. SPG/Steering Group)

B. Operational Structure of the Modified FIL

In the modified FIL modality, the relationships, fund flow, information flow and guaranty flow of those stakeholders under the Shandong EE&ER Project are illustrated as the chart below:

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Under the modified FIL modality, PMO’s functions extend into the financial management of the Project to include:

 preparing the annual contract awards and disbursement projections;

 requesting budgetary allocations for counterpart funds;

 preparing withdrawal applications and sending the withdrawal applications to ADB; and

 collecting supporting documents for the project expenditures incurred by the sub-borrowers. For expenditures eligible under retroactive financing, the sub-borrower will submit its claim to PMO.

The FI will provide the custody service and administrate the escrow account to be established to receive ADB loan proceeds. The FI will onlend to financially viable EE&ER subprojects approved by the PMO. Repayments or partial repayments of sub-loans, net of transfers to SPG for servicing the ADB loan, will be used for further on-lending. By law and under regulatory oversight, the FI is required to administer the funds according to the terms of the escrow account management agreement and may not commingle the funds with other funds. Unlike a normal commercial account, the escrow account will be kept distinct from its own assets and debts, which offers protection against adverse results from other financial operations of the FI. This will help SPG ensure that ADB loan proceeds are only used to implement EE&ER subprojects and not be exposed to other banking risks.

Under the Modified FIL Modality, the FI’s functions will be assisting the PMO in the following administrative functions:

 Assist the project management office (PMO) with on-lending to sub-borrowers;  Conduct financial due diligence on new subprojects and creditworthiness analysis on the new subproject applicants;  Recommend to PMO in approving or rejecting subproject applications from financial assessment aspect;  Manage cash flows on disbursement, interest payment and principal processes and administering sub-loan portfolio;  Manage counter-guarantees, securitization and collateral issued;  Manage exchange of foreign and domestic currencies;  Ensure accounts are audited yearly;  Monitor nonperforming loans; and  Submit monthly report to the PMO.

Where/when appropriate, the FI may provide co-financing of approved new subprojects.

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ADB generally allows PMO and FI to enter into sub-loans meeting agreed criteria without submitting sub-loan proposals to ADB for amounts up to the agreed free limit. The requirement of a free limit, above which sub-loan proposals need to be submitted by the PMO to ADB for prior approval, enables ADB to satisfy itself on the quality of the PMO’s appraisal of projects and to advise on appraisal techniques and methodology for major projects. The free limit is US$15 millions in this case.

C. The Financial Intermediary

ADB’s Operations Manual2 defines and establishes the criteria for eligible financial intermediaries that onlend funds under the FIL modality. These include: (i) financial soundness; (ii) adequate credit and risk financial management practices; (iii) compliance with prudential regulations; (iv) acceptable corporate and financial management practices; (v) sound business objectives and strategy; (vi) autonomy in lending and pricing decisions; and (vii) adequate policies, systems and procedures to assess and monitor the economic, social, and environmental impacts of subprojects. In addition, financial intermediaries should have or develop capacity to mobilize domestic resources. In the past, financial intermediaries have usually been commercial or development banks and the requirements were structured accordingly.

For this Investment Program, China Everbright Bank (CEB)3 has been selected as the financial intermediary to onlend to sub-borrowers. CEB Jinan branch is responsible for managing the loan account and on-lending to sub-borrowers. Accordingly, due diligence assessment was conducted. As indicated in Appendix K, due diligence assessment of CEB Jinan branch concluded that it is financially sound, has adequate risk and management policies, acceptable corporate and financial management practices, and complies with regulatory requirements.

The FIL is designed to revolve the ADB funding by establishing a separate escrow revolving account with the selected financial intermediary.4 The involvement of China Everbright Bank (CEB), a commercial bank, in rolling over the fund will bring in sound banking expertise and governance in energy efficiency lending. It will also strengthen cooperation between the government agency (the PMO) and the domestic financial institution, which may encourage them to work together beyond the project and expand investments in this high priority area for the government.

2 ADB. 2003. Operations Manual. Section D6/BP: Financial Intermediation Loans. Manila. 3 SFB has selected CEB, Jinan branch as the financial intermediary through a bidding process conducted in May 2010. 4 Shandong Provincial Finance Department selected CEB, Jinan branch, as the financial intermediary through a bidding process conducted in May 2010.

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D. Specific Terms of the Modified FIL Modality

Tenures of the Loan and Sub-loans: To maximize the benefit from the revolving nature of the financing, the term of each sub-loan will be no more than 6 years, including a grace period of 2 years. The loan repayment term for all subprojects will match the payback period for each batch. The on-lending interest rate will be set within the allowable band of the rate permissible by the People’s Bank of China for a commercial loan, which would be 10% lower than the current prime rate of the same term.5 The SFB will bear the risks of currency exchange and interest rate fluctuations. Only subprojects satisfying the selection criteria presented in Appendix H and technically appraised by the PMO with the assistance of CEB will be financed for subsequent batches.

Rates of the Loan and Sub-loans: SPG has proposed to keep the ADB loan at variable rate based on the 6-month LIBOR plus 0.3% ADB premium (i.e. 0.5%+0.3% at present). The PMO will then onlend to subprojects at a lowest rate permissible by the People’s Bank of China for a commercial loan, which would be 10% lower the current prime rate of the same term.6 In this case, the PMO and ADB agree that the FI will onlend to those sub-borrowers at 5+ years loan at the current fixed rate of 5.36%, a 10% discount from the current central bank prime rate of 5.94% for commercial loans. The spread of interest rates is hence 4.66% at present and may be narrower in the future depending on the financial market fluctuation. The SPG may decide whether/when and how to swap the variable rate loan into a fixed rate loan, if so desired. Hence the risk of rate fluctuation should be borne by SPG.

Escrow Evolving Account: To ensure that ADB loan proceeds, as well as interest payments and principal repayments from the subborrowers are not commingled with the other funds being administered by CEB, a separate escrow revolving account will be established and maintained by CEB for all transactions related to the project and administration of the FIL. This will ensure that the account is kept distinct from CEB’s own assets and provide protection against adverse results from other CEB financial operations. Since the loan proceeds will not be relent to CEB, the requirement to relend ADB proceeds to a financial intermediary on terms no more favorable than

5 Commercial banks in the PRC do not have the complete freedom to set interest rates. However, the People’s Bank of China allows interest rates to deviate from the prime rate within a narrow band to reflect the credit risk of the borrower. The current prime rate in the PRC for the same tenor of the sub-loan is 5.94%. With the 10% discount, the interest rate on the sub-loan will be about 5.35%. The interest differential on the sub-loan will therefore be about 2.75%, if the equivalent fixed interest swap rate on the ADB loan is considered. 6 Commercial banks in PRC do not have the complete freedom to set interest rates. However, the People’s Bank of China allows interest rates to deviate from the prime within a narrow band to reflect the credit risk of the borrower.

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ordinary capital resources terms is not applicable. Rather than relending the loan proceeds, the funds will be made available to CEB under an escrow arrangement between SFB and CEB.

Shandong Energy Efficiency and Emission Reduction Account: SFB will establish a Shandong Energy Efficiency and Emission Reduction Account to provide support for the Project. The account will principally be funded from the interest differential between the FIL on-lending rate to the sub-borrowers and ADB’s interest rate.7 To achieve its goals, the account will be used in the following manner:

(i) An average of 50% of the interest spread will be rebated to the subborrowers as a reward for actual energy savings achieved, subject to monitoring and verification by independent consultants; and

(ii) The other 50% of the interest spread will be used to pay for the financial intermediary management fees (approximately 0.2% per annum of the ADB loan amount), and PMO administration costs including procurement of independent consultants for professional services based on the actual amount. These professional services will include (a) appraisal and selection of future subprojects; (b) subproject capacity building, where appropriate; (c) implementation of ADB monitoring and reporting requirements for the project; (d) subproject performance tracking and verification in terms of energy savings and emission reductions; and (e) production of an operations manual as a reference point for future energy efficiency investments in order to replicate the experience gained by the PMO and financial intermediary. To meet these critical needs, a separate PMO account can be opened in accordance with SFB’s procedure.

Disbursement: Disbursements will be in accordance with ADB’s Loan Disbursement Handbook (2007, as amended from time to time)8 and detailed arrangement agreed upon between the government and ADB. The loan proceeds will be paid through SFB’s account that will be setup with the CEB upon loan effectiveness. Such loan proceeds will be transferred from SFB to the escrow revolving account with CEB within five working days of receipt of funds by SFB from ADB following necessary domestic procedures. The escrow account will be managed by CEB. The initial withdrawal request for a particular subproject loan will be supported by a withdrawal application, and certification from SFB that the sub-loan and subproject agreements for the subproject have been executed between the PMO, CEB, and the related

7 Provision of additional counterpart funding will cover any funding shortfalls as specified in the loan agreement. 8 Available at: http://www.adb.org/Documents/Handbooks/LoanDisbursement/loan-disbursement-final.pdf

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sub-borrower, respectively, and include terms and conditions specified in related legal agreements with ADB, and are legally binding upon the parties. This certification will be a condition for the initial disbursement for each sub-borrower. Each withdrawal request needs to be supported by a summary sheet using simultaneous application for sub-loan approval and withdrawal (SAW) procedure and the bank statements (only after the initial withdrawal) for the SFB and escrow revolving accounts, for the corresponding period as indicated in the withdrawal application, submitted to monitor adherence to the requirements of transferring from the SFB account to and from the escrow revolving account within five working days of receipt of funds by SFB from ADB following necessary domestic procedures. For sub-loans in excess of the free limit of $15,000,000, copies of the sub-loan and subproject agreements should be submitted together with the SAW statement. Sub-loans in excess of the free limit should be approved by ADB pursuant to the terms of the project agreement [Section 2.02(b)] prior to requesting withdrawal. Sub-loan below the free limit need only be confirmed by ADB before disbursement can be made. The disbursements under each sub-loan may be in several installments based on the readiness of the subproject.

Withdrawal applications must be signed by authorized signatories of the executing agency and submitted to ADB. Withdrawal applications must be sequentially numbered starting with the number one. Counterpart funds advanced to projects will be held in a Government Counterpart Funds/Project Account known as Shandong Energy Efficiency and Emission Reduction Account.

The Government and SPG have agreed that no withdrawals will be made from the loan account in respect of any subproject until the following conditions are met: (i) SFB has certified to ADB that the subproject agreement and sub-loan agreement related to any such subproject, including the terms and conditions satisfactory to ADB, have been duly executed and delivered on behalf of CEB, SFB acting on behalf of SPG, and the sub- borrower, and have become fully effective and binding upon the parties thereto in accordance with their terms; and (ii) SPG has certified to ADB that the ESMS for the project, as prepared by the PMO and approved by ADB, has been endorsed and adopted by the PMO.

Management Fee: The financial intermediary will be paid management fees by SFB for administrating the FIL and its interest will be protected through the escrow revolving account management agreement between SFB and the financial intermediary.

Guaranty and Insurance: The guaranty of the initial three sub-loans is provided to ADB through the Government. The FI shall require sufficient guaranties or collaterals for all future sub-loans.

Accounting: SPG, CEB, PMO, and each subborrower will maintain separate accounts and records by funding source for all expenditures incurred on the Project.

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CEB will submit to SPG and the PMO monthly financial reports. SPG will compile the consolidated project accounts and related financial statements. The EA and the IAs will maintain separate project accounts and records by funding source for all expenditures incurred on the Project. Project accounts will follow international accounting principles and practices prescribed by the Accounting Law of the PRC.

Auditing: SPG will cause the detailed consolidated project accounts to be audited in accordance with international standards on auditing by an auditor acceptable to ADB. The audited accounts will be submitted in the English language to ADB within 6 months of the end of the fiscal year by the executing agency. The annual audit report will include a separate audit opinion on the SFB account, the escrow revolving account, and the Shandong Energy Efficiency and Emission Reduction account, the use of the loan proceeds, and compliance with the financial covenants of the loan agreement. The SPG and PMO have been made aware of ADB’s policy on delayed submission, and the requirements for satisfactory and acceptable quality of the audited accounts. ADB reserves the right to verify the project's financial accounts to confirm that the share of ADB’s financing is used in accordance with ADB’s policies and procedures.

E. Administration of Financial Intermediary

Under the agreement between the PMO and FI, the FI should undertake the financial due diligence duty to select the subprojects. Financial due diligence and analysis comprises a quantitative and qualitative examination in sufficient depth to determine the reliability of the financial data pertaining to the Investment Program and the subprojects, and to determine the acceptability of the following elements:

 discounted cash flow analysis demonstrating that the project's unleveraged cash flow has an acceptable financial internal rate of return, and a positive net present value, using a discount rate that reflects the financial cost of capital;

 assessment of project cash flows to ensure adequate liquidity, solvency, and profitability;

 identification of the scope for requiring subsidies to ensure financial viability at the project level, and ensuring that arrangements are in place to fully finance the project's construction, and O&M cost;

 sensitivity analysis on key risks affecting the financial performance of the subproject, and measures for mitigation of risks thereof, if possible; and

 development of a program with sub-borrower, if needed, to improve the subproject's financial sustainability.

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The PMO should supervision the framework, procedure, working paper and final report of the subproject due diligence undertaken by FI, to ensure that the analysis is undertaken in substantial compliance with the relevant ADB guidelines.

The FI should undertake monitoring of sub-borrowers’ procurement practices and handle the disbursement affairs. ADB review missions will assess the FI’s monitoring work by reviewing, on a random basis, relevant documentation. ADB and FI may request from the sub-borrower relevant procurement documents/certifications for review.

The FI should maintain a financial management system, include record-keeping, for the FIL and the escrow account that is in substantial compliance with relevant ADB guidelines and PMO and approved by PMO and ADB.

ADB will reserve the right to request SPG/PMO to replace the FI in case of material non-compliance or non-performance.

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APPENDIX J: FINANCIAL MANAGEMENT ASSESSMENT OF CHINA EVERBRIGHT BANK CO. LTD

A. Background

The China Everbright Bank (CEB) is a national commercial bank established in 1992 by the China Everbright Group, Ltd., a state-owned investment conglomerate of the People's Republic of China (PRC). It has its headquarter in Beijing and has 38 provincial level branches and 483 sub-branches distributed in major cities of 23 provinces, municipalities and autonomous regions. It also has a representative office in Hongkong and maintains correspondent relationships with many overseas banks worldwide. It has more than 17,000 staff complement. CEB provides financial services to all its retail and corporate clients covering areas of corporate and investment banking, treasury services wealth and asset management, mortgage, credit card, and fund custodianship, among others.

In 1998, CEB acquired the China Investment Bank (CIB), which was established in 1981, as a sole state-owned policy bank. The acquisition resulted in the immediate doubling of CEB’s operational capabilities and CEB benefited from an increase in its domestic market share through synergy and access to CIB’s large customer deposit base. However, the acquisition caused financial problems as well since CEB assumed the bulk of the liabilities and nonperforming assets of CIB.1 CEB launched a series of financial restructuring in 2007 and received a capital injection of CNY 20 billion from the State through China Central Huijin Investment Ltd. (China SAFE Investment Ltd.), a wholly state-owned investment company. The financial restructuring has substantially enhanced CEB’s overall capital strength. By the end of 2009, CEB's total assets reached CNY1,198 billion, with total loans of CNY632 billion. Its operating income is CNY24.3 billion while its net income is CNY7.6 billion. In 2009, CEB was on the list of Best 16 Banks of Asia2, and is also one of the Top 10 Banks of PRC3. CEB plays an important role in the PRC's financial market and a major player in the asset management business. CEB is expected to complete its Initial Public Offering in the Shanghai Security Exchange late this year or early next year. CEB is reportedly also the first Chinese bank becoming a “low carbon“ bank (according to China News Daily, 2010-04-08). The CEB Jinan Branch in Shandong is a major on-lending bank of loans from foreign governments and international financial institutions in Shandong Province, and is familiar with the policies and procedures of Shandong Provincial Finance Department.

1.1 Ownership and Organization

Till end of 2009, CEB has a registered capital of CNY33.43 billion, with the net equity of CNY 48.12 billion. The majority shareholder is China Central Huijin Investment Ltd. (China SAFE Investment Ltd.) with 49.61% stake. The next two largest shareholders, are the China Everbright Group Limited with 5.31%, and China Everbright Limited with 4.45% stake. The top 10 shareholders own 74.07% of CEB.

1 Source: ADB. 2009. Extended Annual Review Report. Equity Investment People’s Republic of China: China Everbright Bank. 2 Recognition given by a chinese financial media called 21 century BUSINESS HERALD accompany with Chinese University of Hongkong and Shanghai Jiaotong University, 2009(state name of award giving body). 3 Recognition given by China Banker (a Magazine) 2009 (state name of award giving body). total 17 national wide banks in china J-1

Top 10 Shareholders of Everbright Bank (As of 17 August 2010) Proportion of Shareholding Name (%) Central Huijin Investment Ltd. 49.61 China Everbright Group Limited 5.31 China Everbright Limited 4.45 China Reinsurance (Group) 3.72 Corporation China Power Finance Co., Ltd 2.03 Shenergy (Group) Co., Ltd 1.98 National Council for Social 1.41 Security Fund Hongta Tobacco (Group) Co., Ltd. 1.39 Aerospace Science and 1.39 Technology Finance Co., Ltd. China Aerospace Science and 1.39 Technology Corporation Baosteel Group Corporation 1.39 Source: Shanghai Stock Exchange.

The organization structure of the CEB is charted as Figure J1. It includes a board of directors with 15 members, and a board of supervisors reporting to the shareholders with 11 members. The board of directors has 5 independent directors. The board of supervisors has an oversight role, and can be divided into 2 committees: the Nomination Committee and the Audit Committee. Five committees report to the board of directors: Nomination and Remuneration Committee, Audit Committer, Risk Management Committee, Related Party Transaction Control Committee, and Strategy Committee. CEB operations are managed by a President with the assistance of 8 vice presidents, and conducted by 25 functional departments and 15 functional committees.

The senior management consists of the president, chairman, secretary of disciplinary committee, five executive vice presidents, one assistant president and one corporate secretary. It has more than 19,000 employees of which 70.8% of them have obtained diplomas at above college level.

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Figure J1: Organization Chart of China Everbright Bank Ltd.

Source: CEB

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1.2 Operations

The Bank’s primary governing body is the general meeting of shareholders, which conducts management and supervision through the Board of Directors and the Board of Supervisors. The President is appointed and authorized by the Board of Directors to take full responsibility for the Bank’s routine management and operation. The Bank employs a single legal person system, in which all branches (sub-branches) are non-independent accounting units, and they conduct business under authorization of the Head Office and report to the Head Office. The Bank has independent and complete business lines and independent business operation competence, and its Board of Directors, Board of Supervisors and Senior Management operate independently.

The roles and responsibilities of shareholders, board of directors, board of supervisors, and management are clearly defined to ensure independence and effective checks and balances. Mechanisms to separate duties and internal controls are in place. The organizational setup and operating procedures are reported to China Banking Regulatory Commission (CBRC), which has the right to examine the company at any time. CEB constantly reviews its operations for potential risks so that mitigating measures may be taken in a timely manner. It has clear procedures for the internal audit mechanism including one internal audit department and two audit committees, which operates independently from other departments and reports directly to the President, the board of directors and the board of supervisors respectively.

CEB's scope of business, as approved by CBRC are: taking deposits from the public; making short-term, medium-term and long-term loans; effecting domestic and overseas payment settlements; accepting and discounting instruments; issuing bonds; acting as agents to issue, underwrite government bonds; trading government bonds and financial institution bonds; engaging in interbank lending; engaging in foreign exchange trading as principal or as agent; engaging in bank card business; providing letters of credit and guarantee services; collecting and making payment as agents and acting as insurance agents; providing safe deposit box services; and other businesses approved by the CBRC. So the existing business can accommodate the responsibilities of the financial intermediary.

Current market conditions are favorable for the growth of CEB, including (i) continued rapid economic development and income growth requiring diversified financial services; (ii) stronger competitive on asset custody business, including entrust loan; (iii) the IPO ( Initial Public Offer) process is smoothly driven ; and (iv) good reputation of CEB among its clients. The challenges that CEB faces include (i) the challenge of fast expanding the scale and scope of CEB; (ii) sustainable and stronger competition in Chinese Banking sector; and (iii) financial market supervisors tend to overregulate and supervise.

The CEB Jinan Branch has engaged in several on-lending or entrust account management business cooperating with international institutions or foreign governments from 1998, such as: the World Bank, 5 projects, total loan amount US dollar 127 mln and JPY 890mln; ADB, 1 project, loan amount US dollar 20mln; German government, 1 project, loan amount Deutsche Mark 47.5mln; Japanese government, 1 project, loan amount JPY 7.6 bln. The ADB loan program on-lending by CEB Jinan Branch was Dryland Sustainable Agriculture Project, Loan number 2474, Project number 38301-01 in 2009, while the Shandong province got the US$20 millions of total US$83 millions.

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1.3 Risk Management

The board of directors establishes CEB’s risk management strategy and the acceptable overall risk limits. The committee also monitors CEB’s risk management environment and regularly assesses CEB’s risk position and risk management strategies and gives advice on the internal controls related to risk management. CEB’s major functional departments which are involved in risk management are the risk management department, credit approval department, special assets resolution department and legal and compliance department. The risk management department is responsible for implementing CEB’s overall risk management system. Besides risk monitoring and control, the risk management department is also responsible for formulating the risk management policies. The credit approval department is responsible for organizing credit ratings and approval activities of corporate and institutional business. Besides risk monitoring and control, the retail risk officer and credit card risk officer are responsible for retail credit approval and credit card approval, respectively. The legal and compliance department is responsible for CEB’s overall legal and compliance risk management. The front end departments such as the corporate banking department and retail banking department carry out the credit businesses according to CEB’s risk management policies and procedures.

CEB initiated the construction of the third phase of the risk management project, a compliance system for the new BASEL Capital Agreement, a personal loan risk analysis system, a market risk model verification system, and an information technology risk management system. CEB continued to improve the vertical risk management organization framework, dispatching credit risk officers to review every business lines. CEB restructured the loan follow-up management functions for corporate banking, and further improved the post-lending management system to be standardized, professional and thorough.

In response to the volatile economic situations, CEB optimized industrial management system, and preliminarily established an early warning system for different industry sectors composed of key risk indicators, expected default frequency and rating. With reference to the practices of international leading banks, CEB has preliminarily established an operational risk identification and evaluation system that consists of operational risk control self-assessment, operational risk events reporting and internal audit and compliance evaluation. It is introducing key risk indicators system for operational risk. CEB has established operational risk reporting system, requiring each business line and branch office to report on operational risk events according to the specified reporting scope, route, style and limit, on weekly and monthly basis. As the regulation of CBRC, the number of staff in internal audit department must take the minimum of 1% of total staffs of a commercial bank.

In CEB and CEB Jinan branch, the internal control responsibility is shared by internal audit department with two staff and legal compliance department with 11 staff. CEB’s internal audit departments and legal and compliance departments cooperate with each other and conduct independent inspection and evaluation of the compliance and risks of all business operations. For the investment program, CEB will undertake the financial due diligence of the subproject applicants, identify risks, and take necessary mitigation measures to control these risks. The internal control system of CEB and CEB Jinan branch will be applied to the sub-borrowers of the investment program.

Both CEB and Jinan Branch are using computerized accounting system with the specialized software provided by SAP, a Germany company and the world's leading provider of business software especially in ERP sector, and approved by CBRC. The accounting items are standardized according to “The accounting System for Business Enterprises” approved by

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Ministry of Finance, 2006. The computer system helps the risk management work more instantly and easily.

Accounting firms conduct annual audits of CEB and historical audited financial statements are available for public disclosure. For the last 3 years, the auditing firm has been KPMG, which had provided the standard opinion letter on the financial statements. Sub-branch offices are randomly selected for individual audits and KPMG audited the CEB Jinan branch as part of the annual bank-wide audit in 2007, but it does not report separate financial statements. Furthermore, CEB is also subject to annual audit by the CBRC and People’s Bank of China.

1.4 Financial Performance

At the end of 2009, CEB's total asset value was CNY1197.7 billion. With the financial restructuring in 2007, phenomenal growth rates in total assets were experienced. Increases were registered at 41% in 2009, 15% in 2008, and 24% in 2007. CEB generated an operating income of CNY24.26 billion, with a net profit of CNY7.64 billion, an increase of 34.8% after excluding the tax preference factor of the year before last year. The growth rates in profit after tax were 4% in 2009, 46% in 2008, and 82% in 2007. Right of equity was 19.43% in 2009. The income structure was further optimized. Fee-based business developed rapidly, contributing to 13% of the bank’s total income, up by 4.2 percentage points compared to 2008. CEB has been, and continues to be, a fast-growing entity accompanying rapid economic development in the PRC.

It has consistently maintained a cushion above the regulatory capital adequacy ratio requirement. In 2009, the core capital adequacy ratio of CEB in 2009 is 6.84% comparing the indicator regulatory authorities of CBRC of minimum 4%. The Capital adequacy ratio (capital to risk weighted assets ratio) is 10.39%, while the regulatory line is minimum 8%. The ratio of asset liquidity (liquidity asset to liquidity liability) is 35.15%, while the regulatory line is minimum 25%. All those three core indicators setted by CBRC according the Basel Capital Accord, show that the financial performance and status of CEB is soundly to keep sustainable banking business.

69.6% of CEB loan portfolio in 2009 is backed by guarantee or secured by either monetary or tangible assets other than monetary assets. Both the balance and ratio of nonperformance loans declined, reaching CNY8,123 million and 1.25%, respectively. Loan structure was continuously optimized, and the proportion of performing loans in total loans increased by 3.72 percentage points. Credit provision coverage ratio increased by 43.97 percentage points to 194.08%. Manufacturing, water and public utility, property development, transportation and storage, lease and business services, and wholesale and retail trade account for almost 60% of the total commercial loan portfolio in 2009. The portfolio appears well diversified with no sector accounting for greater than 15% of the portfolio. Table J1 lists the CEB loans advanced by industry. CEB balance sheet and financial projections is provided in Table J2 and J3 respectively.

J-6

Table J1: Loans and Advances to Customers Loans advanced, by industry 2009 2008 Manufacturing 13.54 14.85 Water, environment and public utility management 11.48 11.79 Property development 9.84 6.83 Transportation, storage and postal services 9.61 10.89 Lease and business services 8.12 6.25 Wholesale and retail trade 6.93 4.94 Production and supply of electric power, gas and water 4.09 7.92 Mining 2.15 3.25 Others 5.46 6.68 Subtotal of corporate loans 71.22 73.40

Personal loans 21.73 19.49 Discounted bills 7.05 7.11 Gross loans and advances to customers 100.00 100.00 Source: CEB

The assets and liability management committee oversees the bank’s overall liquidity risk and is responsible for managing bank-wide liquidity according to regulatory requirements and the principle of prudence. The planning and finance department of the head office monitors middle- term and long-term liquidity and formulates liquidity management strategy, while the treasury department monitors day-to-day cash flow and maintains an appropriate level of high liquidity assets in line with the liquidity management strategy. CEB’s liquidity has been strong and stands at 35.15%, which is well above PRC regulatory requirement of 25%. In terms of its liabilities, CEB has maintained a stable deposit base as a steady source of funding. As of 2009, deposits-to-assets was 86.1%, up from 85.33% in 2008.

CEB's Non Performance Loan (NPL) ratio fell to 1.25% and 2% respectively at end-2009 and end-2008, obvious lower than the line 5% setted by CBRC. Meanwhile loan loss reserve coverage rose to 194% and 150% respectively.

CEB’s credit rating in 2009 from Fitch Ratings are as follows: Individual rating affirmed at 'D/E' and Support rating at '2'. “D” means signifies there are weaknesses of internal and/or external origin, and “2” means the bank has high probability of getting external support. The ratings in 2009 were upgraded from 2008, which were “E” and “3”, respectively and reflected the bank’s improved financial profile. Dagong Ratings, PRC’s biggest national rating company rated CEB in 2009 as follows: credit quality, “AAp”, financial capability, “C-“, outlook, “positive”.

J-7

Table J2: BALANCE SHEET OF CHINA EVERBRIGHT BANK LTD. China Everbright Bank Balance Sheet (Expressed in thousands of RMB, unless otherwise stated 2009 2008 2007 Assets Cash and deposits with central banks 137,366,556 100,284,457 120,638,581 Deposits with banks and other financial institutions 110,545,669 59,404,985 15,376,392 Placements with banks and other financial institutions 9,061,314 19,552,478 12,646,578 Financial assets held for trading 10,401,474 12,668,171 7,508,610 Derivative financial assets 2,584,579 3,758,834 1,619,248 Financial assets held under resale agreements 121,295,098 49,582,387 52,654,969 Interest receivable 3,341,261 3,403,420 2,691,453 Loans and advances to customers 632,115,334 450,520,669 395,103,848 Available -for-sale financial assets 54,617,799 57,661,616 44,923,226 Held-to-maturity investments 73,530,023 61,187,131 69,544,092 Long-term equity investments 134,125 97,904 121,694 Fixed assets 8,825,898 8,022,069 3,748,303 Intangible assets 1,651,671 1,608,240 1,566,140 Deferred tax assets 575,784 736,336 2,240,947 Others assets 41,601,930 23,349,443 8,802,375 Total assets 1,197,648,515 851,838,140 739,186,456

Liability and equity Liability Deposits from banks and other financial institutions 231,260,084 121,694,434 89,721,634 Taking from banks and other financial institutions 23,090,506 3,099,376 326,344 Financial liability held for trading 8,059,225 20,682,456 20,041,458 Derivative financial liability 2,235,746 3,871,257 1,082,743 Financial assets sold under repurchase agreements 14,641,527 6,956,782 38,786,637 Deposits from customers 799,611,303 605,170,169 540,661,242 Employee benefits payable 3,420,302 2,909,617 1,641,675 Taxes payable 752,547 847,726 3,669,612 Interest payable 6,283,742 6,599,083 4,025,974 Provisions 60,424 60,998 197,443 Subordinated debts issued 21,550,000 18,550,000 5,550,000 Other liabilities 38,575,872 28,164,158 8,792,601 Total liabilities 1,149,541,278 818,606,056 714,497,363

Equity Share capital 33,434,790 28,216,890 28,216,890 Capital reserve 6,433,681 1,084,388 -142,303 Surplus reserve 1,157,482 393,081 0 General reserve 5,485,180 1,375,782 0 Retained earnings 1,596,104 2,161,943 （3,385,494) Total equity 48,107,237 33,232,084 24,689,093 Total liabilities and equity 1,197,648,515 851,838,140 739,186,456

Profit and Loss Statement Operating income 24,258,202 24,700,998 20,044,365 Operating expenses -13,734,755 -16,571,576 -11,579,252 Operating profit 10,523,447 8,129,422 8,465,113 Add: non-operating income 52,087 79,125 60,405 Less: non-operating expenses -82,081 -284,506 -136,179 Profit before tax 10,493,453 7,924,041 8,389,339 Less: Income tax -2,849,436 -607,741 -3,350,187 Net Profit 7,644,017 7,136,300 5,039,152

Statement of Cash Flows Net cash flows from operating activities 24,512,177 26,050,521 12,059,870 Net cash flows from investing activities -12,269,372 -12,530,400 -101,435 Net cash flows from financing activities 11,356,986 12,648,159 19,661,729 Effect of foreign exchange rate changes on cash -18,773 -1,091,745 -549,276 and cash equivalents Cash increase/(decrease) for year 23,581,018 25,076,535 31,070,888 Cash and cash equivalents at the end of year 115,848,609 92,267,591 67,191,056 Data source: the annual report 2009/2008/2007 of China Everbright Bank Source: CEB

J-8

Unit: CNY 100 million Table J3: CEB SUMMARY FINANCIAL PROJECTIONS Actual Projected Item 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Profit and Loss Statement Operating Revenues 119.9 138.5 200 247 242.6 311.2 342.4 376.6 414.2 455.7 Operating Expenses 54.7 64.7 115.8 165.7 137.3 176.1 193.8 213.1 234.4 257.9 Net Income 26.9 27.4 50 73 76 97.5 107.3 118.0 129.8 142.7 1.28 1.1 Balance Sheet Equity and Reserves -30 1 247 312 481 578.5 685.8 803.7 933.5 1076.2 Total Assets 5116.6 5932.3 7393 8467 11976 14537 15990.7 17589.8 19348.7 21283.6 Total Liabilities 5143 5931 7146 8155 11495 13958.5 15305.0 16786.0 18415.2 20207.4 Net Assets -26.4 1.3 247 312 481 578.5 685.8 803.7 933.5 1076.2

Statement of Cash Flows Net Cash Flows of Operating 103.2 162 120.6 260.5 245.1 Activities Net Cash Flows of Investing Activities -104.7 -156.9 -1 -125.3 -122.7 Net Cash Flows of Financing -2.7 -2.8 196.6 126.5 113.6 Activities Cash Increase/decrease for Year -4.2 2.3 316.2 261.7 236 Closing Balance 361.1 363.4 679.6 941.3 1177.3

( ) = negative. Source: Asian Development Bank estimates.

J-9

F. Entrusted Loan Management

The energy efficiency entrusted loan account to be established under the Investment Program is protected by CBRC’s rules, as each entrusted loan account is a separate account and cannot be commingled with any other accounts or the proprietary investments of CEB. CEB assigned the Jinan Branch to take in charge of the entrusted loan mission. CEB-Jinan will establish an energy efficiency entrusted loan management committee and unit with separate functions for (i) assessing financial viability of the subprojects; (ii) disbursing funds; (iii) managing the sub-loan portfolio, collaterals and guarantees, and nonperforming loans; and (iv) preparing the relevant financial statements. The committee has 9 members lead by vice president of CEB-Jinan, and comprising chief officers of 7 relevant departments of CEB-Jinan and leader of the unit. The unit will have its own director who is the president of sub-branch of CEB-Jinan with 16 years relevant experience, supported by five deputies for the functional areas of administration, financial accounting, and customer service.

The committee will establish procedures, verify the financial feasibility study of sub-borrowers, check the legal and compliance matters, make credit approving, disbursement approving, monitor sub-borrowers' performance timely, execute the internal audit process, manage the risk matters, coordinate with the CEB Headquarter, PMO and Shandong Financial Bureau, and for initiating any legal proceedings that may prove necessary

The administrative section of the unit will prepare the financial feasibility study report, prepare the sub-loan agreement and relative legal document, disburse the loan, monitor sub-borrowers' performance, and maintain the database of sub-loans. The financial section will manage the financial and accounting systems for the entrusted loan. The customer service section will be responsible for the co-ordination, training, computer system compliance, and so on. CEB-Jinan currently has about 400 staff; this is deemed sufficient for the Investment Program. It has indicated that more staff will be added in the level of sub-branch of CEB-Jinan, if necessary, as the number of sub-loans increase.

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APPENDIX K: REVOLVING EFFECT OF THE $100 MILLION FIL

Under the modified FIL modality, the EA can use subloan repayments to onlend to subprojects selected in subsequent batches. The revolving financing will scale up the benefit of energy savings and emission reductions while the subborrowers benefits from the interest savings within the 15 years loan tenure. In particular, in this case, the FI can collect on average US$25 million principal repayments per year from the first batch three subborrowers, starting 2013. Hence, the PMO can select 2-4 subprojects each year for a subsequent batch of subloans from 2013 onward. The ADB FIL of US $100 million can be amplified to approximately US $308 million within its tenure of 15 years, based on the assumptions outlined Table K1. Detailed simulation table is provided in Table K2.

K-1

Table K1: Effect of $100 Million Revolving FILa Table K1A: Basic

Assumptions ADB Loan Amount Interest Rate of ADB Subloan Tenure 3.57% (US$ million) 100 6 Loan after Swap (Yrs)

ADB Loan Tenure Subloan Grace Interest of Subloan 5.346% 15 1-2 (Yrs) Period (Yrs)

ADB Loan Grace Commitment Fee PMO Management 0.50% 10 0.15% Period (Yrs) of ADB Fee

FI Account Interest Spread 0.20% 50% Management Fee Rebate to Subborrower Table K1B: Key

Results Total Interest Total Loan from Payments to EA Loan Tenure 2011-2025 ADB (US$ million) $100.0 66.73 (US$ million)

Total On-lending Total Interest Total No. of Batches through FI Payments to ADB 45.00 9 $307.9 (US$ million) (US$ million)

Total Revolving Total Interest No. of subprojects Funding Ratio of Spread Rebate to 23+ 307.9% 9.84 financed via FILs FILs Subborrowers (US$ million) Total Investment Total Management Average Actual to EE&ER 4.56% $615.8 Fee Available to 6.30 Interest Rate Subprojects PMO (US$ million) (US$ million) Total Account Total Investment Management Fee Ratio Cofinanced 615.8% 2.52 to FI (US$ million) by ADB Loan

Balance in EA after Full 3.08 Repayment (US$ million) Note: a - Based on a conservative assumption that ADB swaps the 6 months LIBOR-based variable rate at 0.5% to 7 years fixed rate at 3.27%, plus 0.3% ADB premium, and then lend to PMO at 3.57%.

K-2

Table K2: Revolving Effect of $100 Million FIL - Simulation Table (Unit: $ Million) Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10 Y11 Y12 Y13 Y14 Y15 EA Account Total 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2024 Total Cashflow in 55.83 52.35 28.43 29.74 35.48 41.54 20.53 27.91 31.91 31.71 32.20 31.26 22.75 19.15 13.83 474.62 1.Borrowing from ADB 53.00 47.00 100 2.Call in Subloans 2.83 5.35 28.43 29.74 35.48 41.54 20.53 27.91 31.91 31.71 32.20 31.26 22.75 19.15 13.83 374.62 Total Cashflow out 55.28 51.69 5.06 29.64 29.75 35.48 41.55 20.53 27.91 31.91 50.34 23.58 23.24 22.89 22.69 471.54 1.Repayment and Interest 1.91 3.57 3.57 3.57 3.57 3.57 3.57 3.57 3.57 3.57 22.19 22.19 22.19 22.19 22.19 145.00 Payments to ADB 2.On-lending 53.00 47.00 0.00 24.58 24.68 30.41 36.47 15.45 22.83 26.83 26.63 0.00 0.00 0.00 0.00 307.88 Accumulated On-lending 53.00 100.00 100.00 124.58 149.27 179.68 216.15 231.60 254.43 281.26 307.88 307.88 307.88 307.88 307.88 3.Account Manegement Fee to FI 0.11 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.16 0.12 0.08 0.04 2.52 4.Management Fee to PMO 0.27 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.41 0.31 0.21 0.11 6.30 5.Interest Spread Award 0.00 0.42 0.79 0.79 0.80 0.80 0.81 0.81 0.81 0.82 0.82 0.82 0.61 0.40 0.34 9.84 Net Cash 0.55 0.66 23.37 0.10 5.73 6.06 (21.02) 7.38 3.99 (0.20) (18.14) 7.67 (0.49) (3.74) (8.86) 3.08 Accumulated Net Cash 0.55 1.21 24.58 24.68 30.41 36.47 15.45 22.83 26.83 26.63 8.49 16.16 15.68 11.94 3.08 Batch 1 Cashflow out 1.OnLending Out 53.00 47.00 100.00 2.Debt Drawdown and Interest 22.19 22.19 22.19 22.19 22.19 110.96 Payments 2.1Debt Drawdown 18.62 19.29 19.98 20.69 21.43 100.00 2.2Interest Payments 1.91 3.57 3.57 3.57 3.57 3.57 3.57 3.57 3.57 3.57 3.57 2.91 2.22 1.50 0.76 45.00 3.Account Manegement Fee to FI 0.11 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.20 0.16 0.12 0.08 0.04 2.52 4.Management Fee to PMO 0.27 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.50 0.41 0.31 0.21 0.11 6.30 5.Interest Spread Award 0.42 0.79 0.79 0.61 0.41 0.21 0.00 3.23 55.28 51.69 5.06 5.06 4.88 4.68 4.48 4.27 4.27 4.27 22.89 22.76 22.63 22.49 22.34 257.05 Award Rates of Interest Spread 14.74% Cashflow in 1.Borrowing from ADB 53.00 47.00 100.00 2.Repayments of Subloan 2.83 5.35 28.43 28.43 28.43 28.43 121.89 2.1Principal Repayment of 23.08 24.32 25.62 26.99 100.00 Subloan 2.2Interest Payments of Subloan 2.83 5.35 5.35 4.11 2.81 1.44 0.00 0.00 0.00 21.89 55.83 52.35 28.43 28.43 28.43 28.43 0.00 0.00 0.00 0.00

K-3

Net Cashflow in 0.55 0.66 23.37 23.37 23.55 23.74 (4.48) (4.27) (4.27) (4.27) (22.89) (22.76) (22.63) (22.49) (22.34) -35.15 Accumulated Net Cashflow in 0.55 1.21 24.58 47.95 71.50 95.25 90.76 86.49 82.22 77.95 55.06 32.30 9.67 (12.81) (35.15)

Batch 2 Cashflow Out 24.58 0.19 0.19 0.16 0.12 0.08 0.04 0.00 0.00 25.38 1.OnLending Out 24.58 24.58 2.Interest Spread Award 0.19 0.19 0.16 0.12 0.08 0.04 0.00 0.79

Cashflow In 1.31 5.73 5.73 5.73 5.73 5.73 29.97 1.Repayments of Subloan 1.31 5.73 5.73 5.73 5.73 5.73 29.97 1.1Principal Repayment of 4.42 4.65 4.90 5.17 5.44 24.58 Subloan 1.2Interest Payments of Subloan 1.31 1.31 1.08 0.83 0.57 0.29 5.39

Net Cashflow in (23.27) 5.54 5.54 5.57 5.61 5.65 (0.04) 0.00 0.00 4.60 Accumulated Net Cashflow in 0.55 1.21 24.58 24.68 53.77 83.06 84.15 85.49 86.87 82.55 59.66 36.90 14.27 (8.21) (30.56) -30.56 Batch 3 Cashflow Out 24.68 0.19 0.19 0.16 0.12 0.08 0.04 25.48 1.OnLending Out 24.68 24.68 2.Interest Spread Award 0.19 0.19 0.16 0.12 0.08 0.04 0.00 0.00 0.80

Cashflow In 1.32 5.76 5.76 5.76 5.76 5.76 30.10 1.Repayments of Subloan 1.32 5.76 5.76 5.76 5.76 5.76 30.10 1.1Principal Repayment of 4.44 4.67 4.92 5.19 5.46 24.68 Subloan 1.2Interest Payments of Subloan 1.32 1.32 1.08 0.83 0.57 0.29 5.42

Net Cashflow in (23.36) 5.56 5.56 5.60 5.63 5.67 (0.04) 0.00 0.00 0.00 0.00 4.62 Accumulated Net Cashflow in 0.55 1.21 24.58 24.68 30.41 65.25 71.91 78.84 85.85 87.21 64.28 41.52 18.89 (3.60) (25.94) -25.94 Batch 4 Cashflow Out 30.41 0.24 0.24 0.20 0.15 0.10 0.05 0.00 0.00 0.00 31.39 1.OnLending Out 30.41 30.41 2.Interest Spread Award 0.24 0.24 0.20 0.15 0.10 0.05 0.98

Cashflow In 1.63 7.09 7.09 7.09 7.09 7.09 0.00 0.00 0.00 37.08 1.Repayments of Subloan 1.63 7.09 7.09 7.09 7.09 7.09 37.08 1.1Principal Repayment of 5.47 5.76 6.07 6.39 6.73 30.41 Subloan 1.2Interest Payments of Subloan 1.63 1.63 1.33 1.03 0.70 0.36 6.67

K-4

Net Cashflow in (28.78) 6.85 6.85 6.89 6.94 6.99 (0.05) 0.00 0.00 0.00 5.69 Accumulated Net Cashflow in 0.55 1.21 24.58 24.68 30.41 36.47 49.97 63.76 77.67 85.97 70.02 47.21 24.58 2.09 (20.25) -20.25 Batch 5 Cashflow Out 36.47 0.29 0.29 0.24 0.18 0.12 0.06 37.65 1.OnLending Out 36.47 36.47 2.Interest Spread Award 0.29 0.29 0.24 0.18 0.12 0.06 1.18

Cashflow In 1.95 8.50 8.50 8.50 8.50 8.50 44.47 1.Repayments of Subloan 1.95 8.50 8.50 8.50 8.50 8.50 44.47 1.1Principal Repayment of 6.55 6.90 7.27 7.66 8.07 36.47 Subloan 1.2Interest Payments of Subloan 1.95 1.95 1.60 1.23 0.84 0.43 8.00

Net Cashflow in (34.52) 8.22 8.22 8.27 8.32 8.38 (0.06) 0.00 0.00 6.82 Accumulated Net Cashflow in 0.55 1.21 24.58 24.68 30.41 36.47 15.45 37.46 59.58 76.15 68.53 54.09 31.40 8.91 (13.43) -13.43 Batch 6 Cashflow Out 15.45 0.12 0.12 0.10 0.08 0.05 0.03 0.00 15.95 1.OnLending Out 15.45 15.45 2.Interest Spread Award 0.12 0.12 0.10 0.08 0.05 0.03 0.50

Cashflow In 0.83 3.60 3.60 3.60 3.60 3.60 18.84 1.Repayments of Subloan 0.83 3.60 3.60 3.60 3.60 3.60 18.84 1.1Principal Repayment of 2.78 2.93 3.08 3.25 3.42 15.45 Subloan 1.2Interest Payments of Subloan 0.83 0.83 0.68 0.52 0.36 0.18 3.39

Net Cashflow in (14.63) 3.48 3.48 3.50 3.53 3.55 (0.03) 0.00 2.89 Accumulated Net Cashflow in 0.55 1.21 24.58 24.68 30.41 36.47 15.45 22.83 48.44 68.49 64.37 53.46 34.32 11.80 (10.54) -10.54 Batch 7 Cashflow Out 22.83 0.18 0.18 0.15 0.11 0.08 0.04 23.57 1.OnLending Out 22.83 22.83 2.Interest Spread Award 0.18 0.18 0.15 0.11 0.08 0.04 0.74

Cashflow In 1.22 5.32 5.32 5.32 5.32 5.32 0.00 27.84 1.Repayments of Subloan 1.22 5.32 5.32 5.32 5.32 5.32 27.84 1.1Principal Repayment of 4.10 4.32 4.55 4.80 5.05 22.83 Subloan 1.2Interest Payments of Subloan 1.22 1.22 1.00 0.77 0.53 0.27 0.00 5.01

Net Cashflow in (21.61) 5.14 5.14 5.18 5.21 5.25 (0.04) 4.27

K-5

Accumulated Net Cashflow in 0.55 1.21 24.58 24.68 30.41 36.47 15.45 22.83 26.83 52.02 53.04 47.31 33.38 16.12 (6.27) -6.27 Batch 8 Cashflow Out 26.83 0.21 0.21 0.17 0.13 0.14 27.69 1.OnLending Out 26.83 26.83 2.Interest Spread Award 0.21 0.21 0.17 0.13 0.14 0.87

Cashflow In 1.43 6.26 6.26 6.26 6.26 6.26 32.71 1.Repayments of Subloan 1.43 6.26 6.26 6.26 6.26 6.26 32.71 1.1Principal Repayment of 4.82 5.08 5.35 5.64 5.94 26.83 Subloan 1.2Interest Payments of Subloan 1.43 1.43 1.18 0.90 0.62 0.32 5.89

Net Cashflow in (25.39) 6.04 6.04 6.08 6.12 6.12 5.02 Accumulated Net Cashflow in 0.55 1.21 24.58 24.68 30.41 36.47 15.45 22.83 26.83 26.63 33.70 34.01 26.16 15.02 (1.25) -1.25 Batch 9 Cashflow Out 26.63 0.21 0.21 0.16 0.17 27.38 1.OnLending Out 26.63 26.63 2.Interest Spread Award 0.21 0.21 0.16 0.17 0.75

Cashflow In 1.42 7.57 7.57 7.57 7.57 31.70 1.Repayments of Subloan 1.42 7.57 7.57 7.57 7.57 31.70 1.1Principal Repayment of 6.15 6.47 6.82 7.19 26.63 Subloan 1.2Interest Payments of Subloan 1.42 1.42 1.09 0.75 0.38 5.07

Net Cashflow in (25.20) 7.36 7.36 7.41 7.40 4.33 Accumulated Net Cashflow in 0.55 1.21 24.58 24.68 30.41 36.47 15.45 22.83 26.83 26.63 8.49 16.16 15.68 11.94 3.08 3.08

K-6

APPENDIX L: ENVIRONMENTAL ASSESSMENT AND REVIEW FRAMEWORK

This environmental assessment and review framework is prepared for the proposed Shandong Energy Efficiency and Emission Reduction Project (the Project) in Shandong province, People’s Republic of China (PRC). The Project proposes utilizing financial intermediation loan (FIL) of the Asian Development Bank (ADB). The Project will focus energy efficiency improvement and pollution emission reductions in Shandong economy and achieve these targets by technical innovations in energy conservation and environmental protection as well as use of clean coal technology. This environmental assessment and review framework is to guide the Shandong Provincial Government (SPG), the executing agency, in the environmental assessment of subprojects included under the FIL to ensure compliance with the environmental safeguard requirements of ADB.

A. Type of Schemes to Be Assessed

The Project will include energy efficiency and emission reduction subprojects located within Shandong and energy services subprojects provided by Shandong companies. The subprojects may include retrofits or construction of:

 SO2 emission reduction systems;

 CO2 emission reduction systems;  Recovery of waste energy from industry;  Industrial boilers and industrial cogeneration;  Technical upgrade in energy conservation;  Renewable energy subprojects;  Coal washing service subprojects; and  Other related energy efficiency improvement and emission reduction subprojects.

The Project will also provide support for capacity development and information dissemination.

B. Environmental Assessment Procedure

The Project will be implemented in accordance with Shandong’s Road Map and Investment Program for energy efficiency and emission reduction. SPG will be responsible for implementation of the Road Map and Investment Program. The Shandong Project Management Office (PMO) will have the overall responsibility for

L-1

ensuring that all applicable PRC and ADB environmental standards and procedures are followed.

The Project has been classified as environmental category F1, which involves lending through a financial intermediary. The first three subprojects include Shandong Golden Yimeng Group Subproject of Biogas Power Generation, Waste Heat Recovery and Solar Themal Utilization (Golden Yimeng Subproject), Shandong Lufang Subproject of Flue Gas Heat Recovery and Emission Reduction Lufang Subproject) and Shandong Mining Machinery Group Coal Washing Service Subproject (SMM Subproject). These three subprojects have been assessed and are classified as environmental categories B and C in accordance with the ADB’s Environment Policy (2002) and Environmental Assessment Guidelines (2003). The SMM coal washing service subproject is classified as environmental category C because the role of SMM is limited to supplies of advanced coal washing technology, equipment, coal washing management, technical service for coal washing projects located in Shandong and other provinces in China without involving civil and infrastructure works. For each coal washing project, the coal mine company will be responsible for the preparation of detailed environmental assessment report and application for EIA approval, including proper waste management plan, as coal washing project is classified as category A project in China. The other two subprojects are classified as environmental category B and they only require simple environmental assessment. The rapid environmental analysis checklists of these subprojects are shown in attachments L1 and L2.

The Golden Yimeng subproject consists of biogas recovery and use, technical upgrade for energy conservation, waste heat recovery and solar energy use. The subproject uses existing industrial land with resettlement issue. The main environmental impacts include certain dust and noise pollution during project construction, generation of bio-liquid and bio-waste during biogas generation, certain noise pollution from steam turbine and water pump, heat pollution from warm water discharged and smell pollution due to possible biogas leakage. The mitigation measures include bio-liquid treatment at wastewater treatment plant, treatment of bio-waste by pressure filter for production of organic fertilizer or fuel, use of heat pump technology to reduce the temperature of the wastewater discharged. In general, the potential adverse environmental impacts on human populations or environmentally important areas are small, these impacts are site-specific, with proper environmental mitigation measures, these impacts can be effectively under control.

The Lufang subproject consists of flue gas treatment, waste heat recovery and use. The implementation of the subproject can result in notable energy conservation and emission reduction. The subproject occupies existing industrial land without resettlement issue. The environmental impacts of the subproject mainly include: emission of certain amount of acid containing tail gas, discharge of 3000m3/d wastewater, discharge of 3,310t/a solid waste, discharge arisen contained solid waste

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during waste acid treatment, noise emission from ventilators and blowers. The mitigation measures can be readily designed, which include further treatment of acid contained tail gas, further treatment of acid contained wastewater for reuse, supplying desulfurization gypsum to building material plant, control and isolation for main noise generation equipments etc. The potential adverse environmental impacts on population or environmentally important areas are small; with proper environmental mitigation measures, the environmental impacts can be effectively controlled.

The SMM subproject consists of supply of coal washing technology and equipment, supply of technical services and management, providing necessary financial support. The subproject aims to provide coal washing energy services to coal washing projects with total processing capacity of 20Mt/a, these coal washing projects are located in Shandong or other provinces in China. The subproject owner will use its own expertise and manufacturing facilities to produce advanced coal washing equipment and supply coal washing technical services. Coal washing is one of effective clean coal technology to achieve energy conservation and emission reduction. The implementation of the subproject can realize remarkable benefits in energy conservation and emission reduction. As the subproject uses existing manufacturing facilities to produce coal washing equipment and supplies energy conservation services, the subproject is likely to have minimal or no adverse incremental environmental impacts.

During preparation of subsequent subprojects, the PMO will assess the potential environmental impacts from the subprojects. Based on the assessment, the PMO will categorize the subprojects into one of the following:

 The subprojects requiring an environmental management system, including environmental assessment and review procedures for subprojects; and  The subprojects that will only have insignificant impacts, will require a review of environmental implications.

The PMO will ensure that the environmental review documents comply with ADB environmental safeguard requirements. During assessment of the potential environmental impacts from the future subprojects, the PMO will categorize the subprojects into either category A, B or C, in accordance with ADB’s Environmental Policy (2002) and Environmental Assessment Guidelines (2003) based on the categorization. The subproject owner will submit to ADB the following reports: category A, a summary environmental impact assessment report; category B, a summary initial environmental examination report; and category C, a review of environmental implications. SPG will be responsible to ensure that all PRC and ADB environmental safeguard requirements are being achieved and will maintain a centralized database of all environmental reports that will be made available during ADB review missions.

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C. Environmental and Social Management System

The Project has been classified as financial intermediary for environmental, involuntary resettlement and indigenous people categorization. Accordingly, an environmental and social management system (ESMS) document will be prepared based on the agreed1 ESMS arrangement by the PMO and made available for ADB review prior to first disbursement. This agreed ESMS document will be updated by the SPG, as needed, and submitted to ADB for review as per ESMS requirements. The ESMS will be established and maintained as part of SPG’s overall system in relation to the ADB loan project in order to meet national laws and ADB environmental and social safeguard requirements.

ADB has assisted SPG in the appraising and selection of the first batch of subprojects. The safeguard reporting requirements of the initial subprojects have been accomplished as part of the project preparatory technical assistance (TA) part A work with the exception of annual environmental and social management system (ESMS) implementation report. The nature of work, as reflected in the subproject categories, is not expected to induce any adverse environmental impacts during the construction period for Golden Yimeng and Lufang subprojects. (No social impact is anticipated as land acquisition and adverse impacts on indigenous people have been excluded via subproject selection criteria.) As the SMM subproject uses existing manufacturing facilities to produce coal washing equipment and supplies energy conservation services, the subproject is likely to have minimal or no adverse incremental environmental impacts. Thus, the monitoring records furnished by the subproject companies as part of their domestic environmental license conditions and environmental impact assessment (EIA) requirements will suffice the annual ESMS implementation report which would be forwarded by the PMO to ADB during the 2 years of construction period.

As part of the loan processing an ESMS arrangement has been drafted to guide SPG, the executing agency, to develop their own ESMS as SPG takes on the responsibility of appraising and approving the future subprojects under the FIL. In order to ensure that lessons learned from the first batch are propagated in an efficient manner and quality is maintained, ADB, through its part B PPTA consultants, will develop a comprehensive and simplified procedure for ESMS implementation including various reporting requirements. A training program will also be delivered on the ESMS implementation to the relevant SPG staff responsible for the management of ESMS.

1 The SPG signed a memorandum of understanding on 13 August 2010 confirming the ESMS Arrangement.

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D. Environmental Criteria for Subproject Selection

The following environmental criteria will be utilized in screening/selecting subsequent subprojects:

 The proposed subproject shall be energy efficiency and emission reduction projects located within Shandong province, or such projects located outside Shandong province but Shandong energy service companies are responsible to provide services for these projects;

 The subprojects must not involve any land acquisition or housing demolition. The subproject proposal will be screened through an involuntary resettlement impact screening checklist. The checklist will be submitted to ADB for approval to confirm that no land acquisition or house demolition will be required;

 The subprojects must not be located in any designated environmental protection zone;

 Each subproject must be designed, constructed and operated in accordance with relevant national environmental laws and regulations;

 Subproject must meet requirements of the ESMS developed for the Project as approved by ADB;

 The subprojects must not have adverse impacts on ethnic minorities. The subproject proposal will be screened through an ethnic minorities impact screening checklist. The checklist will be submitted to ADB for approval to confirm that there are no adverse impacts on ethnic minorities; and

 Initial Poverty and Social Assessment and Summary Poverty Reduction and Social Strategy shall be prepared for all subprojects.

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Appendix L1:

Rapid Environmental Assessment (REA) Checklist

Country/Project Title: PRC: Biogas Power Generation, Waste Heat Recovery and Solar Thermal Utilization Project by Golden Yimeng Group Co. Ltd

Sector Division: Energy

SCREENING QUESTIONS Yes No REMARKS A. Project Siting Is the Project area adjacent to or within any of the following environmentally sensitive areas? The subproject is located at Linsu Economic Development Area, Linyi, Cultural heritage site Shandong, it only occupies industrial land which is owned by Golden Yimeng Group Co. Same as the above Protected Area

Wetland Same as the above Mangrove Same as the above Estuarine Same as the above Buffer zone of protected area Same as the above Special area for protecting biodiversity Same as the above B. Potential Environmental Impacts Will the Project cause… impairment of historical/cultural monuments and other The subproject only occupies existing areas, and loss/damage to these sites? industrial land, and is closely associated with an existing organic chemical project. . encroachment into precious ecosystem (e.g. sensitive The subproject is located in the Linshu habitats like protected forest areas or terrestrial wildlife Economic Development Zone, only habitats? occupies industrial land. dislocation or involuntary resettlement of people? Same as the above aesthetic degradation and property value loss due to Same as the above establishment of plant and ancillary facilities? social conflicts between construction workers from other Local people will be used as far as areas and community workers? possible during project construction.

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SCREENING QUESTIONS Yes No REMARKS noise and dust from construction activities? The construction activities will generate temporary noise and dust, the nearest village is about 700m away from the project site, the noise and dust impact is small. short-term soil erosion and silt runoff due to construction? Construction activities such as foundation excavation, waste soil piling will lead to short-term soil erosion. fugitive dust during transportation, unloading, storage, and There is no coal use for the subproject. processing of coal, and polluted runoff from coal storage? risk of oil spills, which could pollute surface and There is no risk of oil spills involved in the groundwater and soil? subproject. hazards in gas pipeline operation and gas storage at power Biogas is a kind of explosive gas, gas plant sites? pipeline and storage facilities are required for the subproject. changes in flow regimes downstream of the water intake The subproject only requires 67 m3/h due to abstraction for cooling purposes? freshwater, and water is supplied by existing water supply system. pollution of water bodies and aquatic ecosystem from The waste water from biogas generation wastewater treatment plant for boiler feed, bleed-off from system will be treated by existing waste cooling towers, boiler blowdown and wash-water, and water treatment plant, the treated water is effluent from ash pond? required to reach the “Water pollutants comprehensive discharge standard for South-North Water Diversion Project in Shandong”(DB37/599-2006). Other waster water such as acid and alkali wastewater and boiler system wastewater will be treated and reused for watering trees ,grass and dust control. air pollution from fuel gas discharged into the atmosphere? Flue gas contains certain amount of NOx

and SO2 from biogas combustion, their environmental impact is minimal. public health and safety hazards due to solid waste disposal The sludge from biogas generation system in sanitary landfills (see Matrix of Impacts and Measures for is treated as either bio-fuel or organic Solid Waste Disposal)? fertilizer.

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Appendix L2:

Rapid Environmental Assessment (REA) Checklist

Country/Project Title: Flue Gas Heat Recovery and Emission Reduction Subproject by Dongying Lufang Metallic Materials Co. Ltd. (Lufang)

Sector Division: Energy

SCREENING QUESTIONS Yes No REMARKS A. Project Siting Is the Project area adjacent to or within any of the following environmentally sensitive areas? The subproject is located at an existing cooper production factory, it only occupies Cultural heritage site industrial land which is owned by the project owner. Same as the above Protected Area

Wetland Same as the above Mangrove Same as the above Estuarine Same as the above Buffer zone of protected area Same as the above Special area for protecting biodiversity Same as the above B. Potential Environmental Impacts Will the Project cause… impairment of historical/cultural monuments and other The subproject only occupies industrial areas, and loss/damage to these sites? land, there is no historical/cultural monuments in the vicinity of the project site.. encroachment into precious ecosystem (e.g. sensitive The subproject only occupies industrial habitats like protected forest areas or terrestrial wildlife land. habitats? dislocation or involuntary resettlement of people? The land used for the project belongs to industrial land, there is no need for resettlement.. aesthetic degradation and property value loss due to The subproject is located in an industrial establishment of plant and ancillary facilities? park, social conflicts between construction workers from other Same as the above areas and community workers?

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SCREENING QUESTIONS Yes No REMARKS noise and dust from construction activities? The construction activities will generate temporary noise and dust emissions. As there is no residential area near the project site, the noise impact is small. short-term soil erosion and silt runoff due to construction? Short-term and limited soil erosion will happen during project construction. fugitive dust during transportation, unloading, storage, and No coal will be used for the subproject processing of coal, and polluted runoff from coal storage? risk of oil spills, which could pollute surface and There is no risk of oil spills. groundwater and soil? hazards in gas pipeline operation and gas storage at power There is no gas involved in the subproject. plant sites? changes in flow regimes downstream of the water intake The fresh water consumption by the due to abstraction for cooling purposes? subproject is 13773m3/d, the water is from local reservoir. The water is supplied by local water supply company. pollution of water bodies and aquatic ecosystem from All the wastewater is treated and reused wastewater treatment plant for boiler feed, bleed-off from by the subproject and the copper melting cooling towers, boiler blowdown and wash-water, and factory. effluent from ash pond? air pollution from fuel gas discharged into the atmosphere? The waste gases (687405m3/h) from different sources are combined and enter into desulfurization system for further treatment. The SO2 concentration in the treated waste gas is reduced to below 100mg/m3, far below the emission standards (960mg/m3) required by the “Air pollutants comprehensive emission standards” (GB16297-1996).

public health and safety hazards due to solid waste disposal The solid waste (gypsum 13852t./a)from in sanitary landfills (see Matrix of Impacts and Measures for desulfurization system is reused as raw Solid Waste Disposal)? material for cement production. The arsen contained solid waste will be collected and treated by local qualified environmental company.

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APPENDIX M: SUBPROJECT ECONOMIC ANALYSIS

A. Introduction

An economic evaluation was carried out for each of the three initial subprojects. The economic benefits of the first batch subprojects were calculated to assess the economic viability of the subprojects. The economic analyses were performed according to ADB’s Guidelines for Economic Analysis of Projects (1997). The economic costs include capital costs, and operation and maintenance costs. The economic benefits mainly include the cost savings of electricity and coal and sales of other by-products (e.g. organic fertilizers and sulfuric acid). The environmental benefits of avoided air emissions were also considered to account for shadow exchanges of SO2, NOx and PM emissions and prevailing price of GHG emission reduction credits under the Clean Development Mechanism (CDM).

B. Macroeconomic Context

The People’s Republic of China (PRC) has achieved unprecedented economic growth in the past three decades. However, widening inequality and environmental sustainability are highlighted as imminent issues. The PRC government has directed its policy toward an energy efficient economy during the Eleventh Five-Year Plan (2006–2010); the policy trend is expected to be reinforced in the Twelfth Five-Year Plan (2011–2015). Shandong Province’s gross domestic product has sustained high growth momentum, expanding at 12.5% per annum during 1988–2008 and representing 11% of the national gross domestic product. Shandong Province consumed 216 million tons standard coal equivalent (tsce), accounting for nearly 8% of the national total. It is among the largest emitters of air pollutants in the PRC. Industry subsectors absorbed more than three-quarters of provincial energy consumption, predominately provided by carbon-intensive coal. Since 2000, most large cities in the province have had increases in the number of days when the ambient air quality failed to meet national standards. In 2007, Shandong Province set targets to improve energy efficiency by 22% and reduce sulfur dioxide emission by 20% during the Eleventh Five-Year Plan (2006–2010). Steep target for energy efficiency improvement is expected for the Twelfth Five-Year Plan (2011–2015) as the PRC Government announced the plan in November 2009 to reduce carbon intensity of its GDP by 40%–45% by 2020 from the 2005 base level. This project is expected to contribute to the government’s effort to move to an energy efficient economy and livable environment.

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C. Economic Rationale

Given the policy environment, industries will be left with little choice but to adopt energy efficient technologies. However, the adoption by industries and financing by domestic banks in energy efficient technologies have been slow. Among the major factors that hinter investment in energy efficient technologies is the perception of uncertain financial viability associated with the investments. This project aims to mitigate the perception of uncertainty by showcasing successful implementation of energy efficiency subprojects in key manufacturing industries. The selection of leading companies in their respective areas is to maximize the demonstration effect. Their successful implementation will help other large and medium-sized enterprises realize that savings from reduced energy consumption will outweigh the adverse that may be caused by a temporary interruption of operation. Involvement of the commercial bank as FI in the Project is primarily for effective and sustainable management of the ADB loan; and at the same time, also help demonstrate a workable modality—revolving fund system—that the banking system can replicate. It is envisaged that the Project will help unleash financing in clean technologies and help Shandong Province and the PRC attain set targets on energy efficiency and emission reduction in the medium term. Further, this project will help demonstrate that the costs of pollution abatement can be internalized and that economic growth can be achieved in parallel with environment improvement.

D. Economic Parameters and Assumptions

Incremental costs and benefits were determined for each subproject with and without the subprojects to determine the net benefit streams. The economic life of the Project was assumed to be 20 years. The residual value at the end of the economic life was assumed to be zero. All prices and costs were expressed in 2010 values. A constant exchange rate of CNY6.8/$ (prevailing at the time of appraisal) was used in the analysis.

E. Economic Costs

Economic costs were calculated at 2010 prices and were expressed in domestic currency. Tradable commodities were valued at border prices at the prevailing exchange rate. Non-tradable commodities were valued through shadow prices using a standard conversion factor of 0.987; and specific conversion factors of 1.0 for equipments and civil works, 2.0 for skilled labour, and 0.67 for unskilled labour. The capital costs were also adjusted to eliminate price inflation, interest during construction, and taxes1.

1 The taxes used in this evaluation are 25% for normal income tax rate, 17% for local value added tax and 5% for construction tax.

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The operating costs, including the costs of raw materials, energy inputs, salaries, overheads and administration expenses etc., are assumed to remain constant in real terms. No significant growth in the number of total employees is expected with the subprojects. The new machinery to be installed will require less repairs and maintenance and hence overhead costs are projected to remain stable. For the operating cost components, a conversion factor was used in deriving its economic value.

F. Economic Benefits

The economic benefits are derived mainly from: (i) energy savings through the adoption of energy conservation measures, and (ii) the main output of each subproject including sales of by-products, power generation and sales of steam for heat supply. For the economic calculation, the produced by-products were valued at their financial prices without further adjustment by applying conversion factors2. However, the prices of major energy inputs (coal and electricity tariff) were adjusted in the economic calculation.

Electricity tariffs from the state grids are determined by a complicated formula that does not necessary reflect the market demand and supply. Therefore, a consumer’s willingness to pay (WTP) approach was used in determining the economic value of electricity. For estimating the WTP for electricity, reliable information on distribution of electricity generation between different consumer classes was available at Shandong Province level. Accordingly the analysis was performed at the consumer class level and four classes of electricity consumers - agricultural, residential, commercial, and industrial - based on published information at the provincial level. Irrigation is the main use of electricity in the agricultural sector and diesel-fueled engines would be the only viable alternative in the absence of electricity. The cost for diesel powered backup electricity generation is about CNY4.09 per kWh, taking into account for the total lifecycle cost of diesel generation. Residential consumers with no access to electricity were assumed to mainly use gas lamps to serve as the main source of lighting and the cost of this alternative is about CNY 4.04/kwh. Air-conditioning, heating and lighting are the main uses of electricity for commercial users. Petrol generators normally serve as backup sources of energy when electricity supply from the power grid is in adequate. Thus, petrol generators were selected as the alternative at a cost of CNY 3.84/kWh. Industrial users, with high energy consumption, are most sensitive to the cost for electricity supply compared with other consumer classes. In remote areas where grid connection is not available, small sized coal fired power plant is a common choice for alternative energy. In this analysis, a coal fired power plant (12MW) was used as the alternative energy source for industrial users. The cost of this alternative is calculated at CNY0.83/kwh. WTP calculation assumed consumers

2 Tariff for organic fertilizer is assumed to be CNY 663 /ton and CNY180 /ton for sulfur acid.

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would be willing to pay more - about 35% of the difference between the current tariff and the cost of alternative - than the current tariff for extra units of reliable electricity3. Accordingly, the WTP for residential, agricultural, commercial and industrial consumers were calculated at CNY1.74/kwh, CNY1.68/kwh, CNY1.91/kwh and CNY0.66/kwh, respectively. Based on actual sales in 2008, the proportion (by volume) of each class of consumer is agricultural 2.4%; residential 10.1%; commercial 7.0%; and industrial 80.5%. The weighted average WTP is calculated as CNY0.8891/kWh. This figure represents the average WTP for incremental electricity supply – generation and transmission/distribution combined. A split between the generation and transmission/distribution is assumed to be 70:30 and the true value of the WTP for incremental generation is calculated to be CNY0.62/kWh, excluding the proportion for transmission and distribution.

Coal prices are no longer controlled directly by the government and the market-oriented coal price reform has been completed. However, there are distortions in the coal market mainly because of its monopolistic market structure in certain areas and transportation constraints (for example, a quota is needed to transport coal). There are wide variations in coal prices in the country; they range from about CNY 400 to CNY 800 per ton. The economic value of coal could be estimated by the coal extraction cost and depletion premium per ton from 2009 to the future 30 years, but the data is unavailable. Therefore, the FOB of coal at Qinhuangdao Seaport was used as a benchmark to calculate the economic price of coal, which is comparable to the international price. In the current report, CNY 610 per ton at Qinhuangdao Seaport in 2009, plus loading and unloading charges, and regular freight toll to the project site, was used as the economic price of coal.

G. Environmental Benefits

The Project will also result in substantial environmental benefits through the reduction of air and water emissions. Table M1 provides a summary of the annual emission reduced by each project for each pollutant. An economic evaluation of the environmental impacts was carried out based on the benefit transfer method (BTM). The evaluation used the methodology adopted in the Asian Development Bank’s Workbook on Economic Evaluation of Environmental Impacts (1996) to determine the adjusted estimate of the monetary damages caused by air pollution during the study period, taking into account the location of the pollution sources, the emission level, and the population affected. The BTM allows using results from similar valuations conducted in the different parts of the world with proper adjustments to any particular Project. To adjustments of the data from the results of original research in USA to the PRC in 2009 to reflect GDP differentials and medical cost level differentials between USA and the PRC, and update of the price level to 2009 constant prices.

3 An assumed 35% consumer surplus adopted in the past similar ADB evaluations

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Table M1: Estimates of Energy Saving and Emission Reduction For the Three Initial Subprojects

Item Golden YimengSMM Lufang Total

Energy Saving 95,448 761,823 62,426 919,697 (tce/yr)

CO2 (t/yr) 663,054 1,861,426 159,241 2,683,721

SO2 (t/yr) 341 21,102 645 22,088

Smoke (t/yr) 190 1505 124 1,819

NOx (t/yr) 771 6,116 504 7,391

CO (t/yr) 277 2,194 181 2,652 Source: Subproject feasibility study reports and ADB estimates.

Table M2 summarizes the adjusted values for environmental impacts. For global environmental benefits, it is even more difficult to predict and estimate the physical and economic benefits due to CO2 emission reduction by the energy conservation. However, since China is actively participating in the Clean Development Mechanism under the Kyoto Protocol, the Chinese floor price of certified CO2 reduction is used in the approximation of the global environmental value of per ton CO2 reduction. The current price is US$10 per ton of CO2, which is used in the analysis.

Table M2: Adjusted Unit Value for Environmental Emissions (CNY 2009/1,000 Mt/person) Local Damages Regional Damages Distant Damages (within 30 km) (within 100 km) (within 500 km) Pollutant

Low High Low High Low High

Particulates (PM10) 1.762 2.642 0.881 2.642 0.352 0.705

Sulfur Dioxide (SO2) 0.352 0.705 0.176 0.352 0.088 0.176

Nitrogen Oxides (NOX) 0.528 0.705 0.352 0.528 0.088 0.176 Note: The deflator used to convert the data was taken from the MUV G-5 Index and the Shadow exchange rate was utilized.

H. Estimation of Economic Internal Rate of Return (EIRR)

The Project will transfer technology to improve industrial energy efficiency that will help reduce costs, improve productivity, and mitigate the environmental impacts of industrial activities in the future. The demonstration projects would have a multiplier effect and contribute to the systemic benefits from the implementation of energy conservation and environmental improvement in the energy-intensive subsectors.

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However, quantification of many other benefits, such as increase in productivity and improvement of product quality, remain a challenge because of methodological difficulties and lack of data. However, even the highly conservative projection of EIRRs, which take into account only the currently quantifiable benefits of various components, are already substantially higher than the generic economic discount rate of 12%, commonly acceptable by international finance institutes. The estimated EIRRs for the three subprojects range from 20.7% to 37.5% without the environmental benefits and 37.5% to 48.7% with the environmental benefits. The overall EIRR for the whole subprojects is calculated to be 28.9% without environmental benefits and 42.4% when environmental benefits are included. Table M3 summarizes the EIRRs and economic net present values (ENPV) for the three initial subprojects. Detailed computations of EIRRs and ENPVs for the three subprojects and the project as a whole are presented in Table M4 through Table M7.

Table M3: Summary of EIRRs and ENPVs of the Three Initial Subprojects

Subproject Without Environmental Benefits With Environmental Benefits EIRR (%) ENPV (CNY million) EIRR (%) ENPV (CNY million) Golden Yimeng 28.0 381.6 37.5 654.9 Lufang 37.5 771.7 40.3 872.4 SMM 20.7 204.2 48.7 1,085.8

Total 28.9 1,167.0 42.4 2,613.1

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Table M4: EIRR Calculation for Golden Yimeng Subproject (CNY million) Benefits Costs Net Benefits Net Year Coal Electricity Heat Organic Environmental Investment O & without Total Total Benefits Saving Generation Generation Fertilizer Benefits Costs M Env Benefits

2011 0.0 0.0 0.0 0.0 0.0 0.0 186.7 0.0 186.7 (186.7) (186.7)

2012 0.0 0.0 0.0 0.0 0.0 0.0 188.1 0.0 188.1 (188.1) (188.1)

2013 42.9 24.7 44.4 37.5 46.0 195.5 28.7 28.7 166.8 120.8

2014 42.9 24.7 44.4 37.5 46.2 195.7 28.7 28.7 167.0 120.8

2015 42.9 24.7 44.4 37.5 46.4 195.9 28.7 28.7 167.2 120.8

2016 42.9 24.7 44.4 37.5 46.7 196.2 28.7 28.7 167.5 120.8

2017 42.9 24.7 44.4 37.5 46.9 196.4 28.7 28.7 167.7 120.8

2018 42.9 24.7 44.4 37.5 47.1 196.6 28.7 28.7 167.9 120.8

2019 42.9 24.7 44.4 37.5 47.4 196.9 28.7 28.7 168.2 120.8

2020 42.9 24.7 44.4 37.5 47.6 197.1 28.7 28.7 168.4 120.8

2021 42.9 24.7 44.4 37.5 47.8 197.3 28.7 28.7 168.7 120.8

2022 42.9 24.7 44.4 37.5 48.1 197.6 28.7 28.7 168.9 120.8

2023 42.9 24.7 44.4 37.5 48.3 197.8 28.7 28.7 169.1 120.8

2024 42.9 24.7 44.4 37.5 48.6 198.1 28.7 28.7 169.4 120.8

2025 42.9 24.7 44.4 37.5 48.8 198.3 28.7 28.7 169.6 120.8

2026 42.9 24.7 44.4 37.5 49.0 198.6 28.7 28.7 169.9 120.8

2027 42.9 24.7 44.4 37.5 49.3 198.8 28.7 28.7 170.1 120.8

2028 42.9 24.7 44.4 37.5 49.5 199.0 28.7 28.7 170.4 120.8

2029 42.9 24.7 44.4 37.5 49.8 199.3 28.7 28.7 170.6 120.8

2030 42.9 24.7 44.4 37.5 50.0 199.5 28.7 28.7 170.9 120.8

at NPV 12% 273.3 374.8 654.9 381.6

EIRR 37.5% 28.0% Source: Asian Development Bank estimates.

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Table M5: EIRR Calculation for Lufang Subproject (CNY million) Benefits Costs Net Benefits Waste Net Year Coal Electricity Heat Sulfur White Env. Investment without Gypsum Total O & M Total Benefits Saving Generation Generation Acid Arsenic Benefits Costs Env. Residue Benefits

2011 0.0 0.0 0.0 0.0 0.00 0.0 0.0 0.0 153.1 153.1 (153.1) (153.1)

2012 0.0 0.0 0.0 0.0 0.00 0.0 0.0 0.0 298.0 298.0 (298.0) (298.0)

2013 25.4 24.4 19.7 186.0 0.14 2.2 13.9 271.7 101.4 101.4 170.4 156.5

2014 31.8 30.5 24.6 232.5 0.17 2.7 17.4 339.8 118.2 118.2 221.6 204.2

2015 31.8 30.5 24.6 232.5 0.17 2.7 17.5 339.9 118.2 118.2 221.7 204.2

2016 31.8 30.5 24.6 232.5 0.17 2.7 17.6 339.9 118.2 118.2 221.8 204.2

2017 31.8 30.5 24.6 232.5 0.17 2.7 17.7 340.0 118.2 118.2 221.9 204.2

2018 31.8 30.5 24.6 232.5 0.17 2.7 17.8 340.1 118.2 118.2 222.0 204.2

2019 31.8 30.5 24.6 232.5 0.17 2.7 17.9 340.2 118.2 118.2 222.1 204.2

2020 31.8 30.5 24.6 232.5 0.17 2.7 18.0 340.3 118.2 118.2 222.1 204.2

2021 31.8 30.5 24.6 232.5 0.17 2.7 18.1 340.4 118.2 118.2 222.2 204.2

2022 31.8 30.5 24.6 232.5 0.17 2.7 18.1 340.5 118.2 118.2 222.3 204.2

2023 31.8 30.5 24.6 232.5 0.17 2.7 18.2 340.6 118.2 118.2 222.4 204.2

2024 31.8 30.5 24.6 232.5 0.17 2.7 18.3 340.7 118.2 118.2 222.5 204.2

2025 31.8 30.5 24.6 232.5 0.17 2.7 18.4 340.7 118.2 118.2 222.6 204.2

2026 31.8 30.5 24.6 232.5 0.17 2.7 18.5 340.8 118.2 118.2 222.7 204.2

2027 31.8 30.5 24.6 232.5 0.17 2.7 18.6 340.9 118.2 118.2 222.8 204.2

2028 31.8 30.5 24.6 232.5 0.17 2.7 18.7 341.0 118.2 118.2 222.9 204.2

2029 31.8 30.5 24.6 232.5 0.17 2.7 18.8 341.1 118.2 118.2 223.0 204.2

2030 31.8 30.5 24.6 232.5 0.17 2.7 18.9 341.2 118.2 118.2 223.1 204.2

at NPV 12% 100.7 451.2 872.4 771.7

EIRR 40.3% 37.5% Source: Asian Development Bank estimates.

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Table M6: EIRR Calculation for SMM Subproject (CNY million) Benefits Costs Net Benefits Net Year Coal Transportation Environmental Investment without Total O & M Total Benefits Saved costs saving Benefits Costs Env. Benefits

2011 0.0 0.0 0.0 0.0 242.6 242.6 (242.6) (242.6)

2012 0.0 0.0 0.0 0.0 133.5 133.5 (133.5) (133.5)

2013 384.3 180.5 148.3 713.0 473.5 473.5 239.5 91.2

2014 384.3 180.5 149.0 713.8 473.5 473.5 240.2 91.2

2015 384.3 180.5 149.7 714.5 473.5 473.5 241.0 91.2

2016 384.3 180.5 150.5 715.3 473.5 473.5 241.7 91.2

2017 384.3 180.5 151.2 716.0 473.5 473.5 242.5 91.2

2018 384.3 180.5 152.0 716.8 473.5 473.5 243.2 91.2

2019 384.3 180.5 152.8 717.5 473.5 473.5 244.0 91.2

2020 384.3 180.5 153.5 718.3 473.5 473.5 244.8 91.2

2021 384.3 180.5 154.3 719.1 473.5 473.5 245.5 91.2

2022 384.3 180.5 155.1 719.8 473.5 473.5 246.3 91.2

2023 384.3 180.5 155.8 720.6 473.5 473.5 247.1 91.2

2024 384.3 180.5 156.6 721.4 473.5 473.5 247.9 91.2

2025 384.3 180.5 157.4 722.2 473.5 473.5 248.6 91.2

2026 384.3 180.5 158.2 723.0 473.5 473.5 249.4 91.2

2027 384.3 180.5 159.0 723.7 473.5 473.5 250.2 91.2

2028 384.3 180.5 159.8 724.5 473.5 473.5 251.0 91.2

2029 384.3 180.5 160.6 725.3 473.5 473.5 251.8 91.2

2030 384.3 180.5 161.4 726.1 473.5 473.5 252.6 91.2

NPV at 12% 376.2 1,085.8 204.2 881.5

EIRR 48.7% 20.7% Source: Asian Development Bank estimates.

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Table M7: EIRR Calculation for the Whole Project (CNY million) Benefits Costs Net Benefits Net Year Golden Investment without Env. Lufang SMM Total O & M Total Benefits Yimeng Costs Benefits

2011 0.0 0.0 0.0 0.0 582.5 582.5 -582.5 -582.5

2012 0.0 0.0 0.0 0.0 619.7 619.7 -619.7 -619.7

2013 195.5 271.7 713.0 1,180.2 603.6 603.6 576.6 368.6

2014 195.7 339.8 713.8 1,249.2 620.4 620.4 628.9 416.3

2015 195.9 339.9 714.5 1,250.3 620.4 620.4 629.9 416.3

2016 196.2 339.9 715.3 1,251.4 620.4 620.4 631.0 416.3

2017 196.4 340.0 716.0 1,252.4 620.4 620.4 632.1 416.3

2018 196.6 340.1 716.8 1,253.5 620.4 620.4 633.2 416.3

2019 196.9 340.2 717.5 1,254.6 620.4 620.4 634.2 416.3

2020 197.1 340.3 718.3 1,255.7 620.4 620.4 635.3 416.3

2021 197.3 340.4 719.1 1,256.8 620.4 620.4 636.4 529.3

2022 197.6 340.5 719.8 1,257.9 620.4 620.4 637.5 325.2

2023 197.8 340.6 720.6 1,259.0 620.4 620.4 638.6 892.5

2024 198.1 340.7 721.4 1,260.1 620.4 620.4 639.7 121.2

2025 198.3 340.7 722.2 1,261.2 620.4 620.4 640.9 120.8

2026 198.6 340.8 723.0 1,262.4 620.4 620.4 642.0 120.8

2027 198.8 340.9 723.7 1,263.5 620.4 620.4 643.1 120.8

2028 199.0 341.0 724.5 1,264.6 620.4 620.4 644.2 120.8

2029 199.3 341.1 725.3 1,265.8 620.4 620.4 645.4 120.8

2030 199.5 341.2 726.1 1,266.9 620.4 620.4 646.5 120.8

NPV at 12% 7,200.7 1,014.1 4,482.5 4,587.6 2,613.1 1,167.0

EIRR 42.4% 28.9% Source: Asian Development Bank estimates.

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I. Sensitivity Analysis

Sensitivity analysis was carried out for the initial subprojects under three possible adverse scenarios separately and in combination: benefit shortfall, investment cost overrun, simultaneous occurrence of benefit shortfall and investment cost overrun, and delay of benefit inflow (or project delay). With environmental benefits, all subprojects earned substantial switching values, which indicate that economic viability of all subprojects is robust under possible adverse circumstances. Even without environmental benefits, all subprojects are robust in terms of their economic viability. A summary of sensitivity analysis is provided in Table M8.

Table M8: Sensitivity Analysis of EIRR Switching Value Case 3: Case 2: Benefit Case 4: Case 1: Base EIRR Investment Shortfall and Delay in Subproject Benefit (%) Cost Investment Benefit Shortfall Overrun Cost Inflow (%) (%) Overrun (years) (%) With Environmental Benefits Overall Project 42.4% 36.5% 259.5% 32.0% 3 Golden Yimeng 37.5% 58.3% 212.7% 45.7% 7 Lufang 40.3% 45.5% 233.1% 38.1% 4 SMM 48.7% 26.2% 336.0% 15.1% 2 Without Environmental Benefits Overall Project 28.9% 23.1% 135.7% 19.7% 2 Golden Yimeng 28.0% 45.4% 45.4% 33.4% 4 Lufang 37.5% 36.4% 36.4% 28.7% 3 SMM 20.7% 6.3% 63.2% 5.7% 0 EIRR = economic internal rate of return, SI = sensitivity indicator, SV = switching value. Note: Sensitivity indicator is the ratio of percentage change in the EIRR divided by the percentage change in the given parameter. Switching value is the percentage change in a parameter for the project decision to change, that is, for the net present value to become zero or the EIRR to fall to the cut-off rate. Source: Asian Development Bank estimates.

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APPENDIX N: SUBPROJECT FINANCIAL ANALYSIS

Appendix N1:

Financial Performance of Initial Subborrowers

The sub-borrowers of the three initial subprojects, Golden Yimeng, Lufang and SMM, are leaders in their respective industrial subsectors. The key financial performance indexes of these three subborrowers for the past four years (2006-2009) have been reviewed based on the audited financial statements provided by the subborrowers. All three companies have large shareholders’ equity and rights, which can support substantial debt financing from commercial banks. In particular,

 Golden Yimeng is a large private-owned enterprise group and a leading supplier of acetate esters, organic aldehydes, composite fertilizers and fermented alcohol in China. Its total assets approached CNY 2.0 billion at the end of 2009 (with a debt-asset ratio of 64.4%) and sale revenues exceeded CNY 2.1 billion in 2009, with average annual expansion of 30% in the last 4 years. However, its sales growth rate has slowed down recently mainly due to the adverse impact of the global financial crisis. This led to a declining net profit rate on equity (after corporate income taxes), which was averaged at 11.8%. It is expected that the net profit rate on equity can stay at around 8% in the near future, because of steady recovery of the Chinese domestic market.

 Lufang is a wholly-owned subsidiary of Dongying FangYuan Non-Ferrous Metals Co. Ltd, which was established in 1998 and is reportedly the number one private–owned industrial enterprise in China with a total revenue of over CNY12.0 billion in 2008. Lufang was established in 2006 and started production in 2008. Its sales revenues was over CNY 3.0 billion in 2009, and its total assets have accumulated to nearly CNY 1.5 billion by the end of 2009, with a very low debt-asset ratio of 25.4%. Lufang’s net profit rate on equity was 21% in 2009 because its OBBF smelter can utilize inexpensive ores and its products (primarily copper) has been under high demand.

 With a long history of over 50 years, SMM has approximately 2,800 employees and specializes in developing, producing and distributing mining machineries and construction equipments. Its sales revenues was estimated to be around CNY 0.9 billion in 2009 and its total assets were CNY 1.2 billion by the end of 2008 with a debt-asset ratio of 66.2%. Its net profit rate on equity was 14.2% in 2008.

As major employers and tax payers in their respective locations, these companies have obtained strong government support for investing in energy conservation and reduction of pollution emissions. Recognizing the project’s direct contribution to resource conservation and protection of local environment, the local governments have committed to provide guaranties to SPG for the sub-loans from the ADB FIL.

The key financial performance indicators of the three subborrowers for years 2006-2009 are summary Table N1. The SMM’s data does not cover the second half of 2009.

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Table N1: Key Financial Performance Indexes of Subborrowers (CNY million unless otherwise stated) Subproject Golden Yimeng Lufang Shandong Mining Machinery 2006 2007 2008 2009 2006 2007 2008 2009 2006 2007 2008 2009 /a Sales Revenue 1,618.5 2,072.5 2,109.7 2,103.0 245.6 3,094.8 619.6 740.8 851.8 499.3 Gross Profit 76.8 157.0 59.9 61.0 13.7 307.4 51.0 94.8 74.3 35.1 Corporate Income Tax 25.5 30.7 8.2 13.7 3.4 76.8 6.4 19.2 17.3 9.1 Net Profit 51.3 126.3 51.7 47.3 10.3 230.5 44.6 75.6 57.0 26.0

Current Assets 520.4 746.1 1,034.9 999.9 46.0 157.1 248.2 326.9 526.8 657.9 824.0 858.4 Fixed Assets 440.3 745.7 813.0 870.8 257.2 339.2 617.3 1,035.4 203.5 205.8 306.2 306.8 Total Assests 1,063.2 1,602.7 1,954.6 1,975.9 303.4 516.1 917.8 1,469.8 791.2 977.6 1,214.3 1,249.1 Current Liabilities 317.1 673.5 853.2 947.5 3.4 10.3 251.7 372.3 506.2 526.9 668.4 683.1 Long-term Debts 290.3 337.3 444.6 324.3 - 0.3 0.3 1.2 32.8 160.6 144.0 144.0 Shareholders' Euity and Rights 455.7 591.9 656.7 704.1 300.0 505.5 665.8 1,096.3 252.2 289.9 402.0 422.0

Growth Index of Sales Revenue (2006=100) 100.0 128.1 130.3 129.9 100.0 119.5 137.5 80.6 Growth Rate of Assets (2006=100) 100.0 150.7 183.9 185.8 100.0 170.1 302.5 484.4 100.0 123.6 153.5 157.9

Debt-Asset Ratio (%) 57.1 63.1 66.4 64.4 1.1 2.1 27.5 25.4 68.1 70.3 66.9 66.2 Gross Profit Rate of Assets (%) 7.2 9.8 3.1 3.1 - - 1.5 20.9 6.4 9.7 6.1 2.8 Net Profit Rate of Assets (%) 2.4 1.9 0.4 0.7 - - 0.4 5.2 0.8 2.0 1.4 0.7 Net Profit Rate of Equity (%) 11.3 21.3 7.9 6.7 - - 1.5 21.0 17.7 26.1 14.2 6.2 Source: Subproject sponsors and ADB estimates. /a Data for the first 6 months.

An assessment based on the completed financial management assessment questionnaire, supplemented by the submission of relevant documents and interviews, was done for each subproject sponsor. The assessment indicates that accrual basis accounting and PRC business accounting standards are followed. The accounting procedures currently used by the companies are aligned with the regulations and policies issued by the Ministry of Finance, and are considered effective and adequate for the project. The functions related to the authorization, transaction, recording, and asset management are well separated. Computerized accounting system is used and operated by the accounting staff. A complete set of accounting procedures for recording and processing transactions is in place in companies. Internal control is effective. A rigorous budgeting system is uniformly implemented, the budgets cover both financial and physical targets and include sufficient details of the company’s activities. The same accounting systems and procedures will be used for their respective subproject. The companies have an internal audit department, of which the internal auditors are designated to conduct internal audit and report to the board periodically or as needed. Financial statements are regularly audited by external auditors. The audit reports are usually issued within 2 months after the end of the fiscal year or not later than the mandatory submission period. The companies’ organizational structures are generally adequate for the project as well as the current accounting department and its staff. Additionally, both companies have organized a full team on project management including procurement, disbursement, and construction management, among their functions.

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Appendix N2:

Financial Analysis of Initial Subprojects

The objectives of the subproject financial analysis are to: (i) specify and examine critical assumptions and parameters; (ii) analyze the cash flows for the subprojects; (iii) to present the key financial statements for the Project, including the income statement, the sources and uses of funds, and the balance sheet; (iv) evaluate the financial viability of the Project, including the profitability indexes, the net present value, and adequacy of the financial internal rate of return (FIRR); (v) scrutinize debt service coverage ratios (DSCRs), and (vi) conduct -sensitivity analysis and scenario analysis to assess the financial robustness of the Project. As well, the analysis can be used as a template for subsequent subprojects to be identified in the future batches.

The analysis has been performed in accordance with the Asian Development Bank (ADB) guidelines in Financial Management and Analysis of Projects (2005). The analysis focuses on the initial three subprojects identified for funding. The analysis uses the year ending on 31 December 2011 as the base year. The main assumptions of financial forecasts are built on the subproject feasibility studies with adjustments to incorporate findings from the due diligence assessment by the ADB PPTA team. The subproject construction period is assumed to lasts for two years (2011 and 2012). Cost escalation factors have been used to reflect the changes in costs and revenues1. The analysis excludes any potential income from the Clean Development Mechanism (CDM) program for certified emission reductions (CERs).

The analysis has verified that all 3 subprojects are not only technically feasible, environmentally friendly, economically sound, but also financially attractive and robust. However, for a relatively short debt tenure of the sub-loans proposed by SPG, the repayment schedule need to be closely monitored and adjusted timely in case of drastic market shift..

A. Financial Revenues

The subprojects generate financial benefits from (a) energy efficiency improvements in production processes to reduce the sponsors’ expenditure on energy consumption; (b) substitution of coal combustion by utilizing renewable energy (e.g. solar thermal), capturing fugitive methane for power generation and heat supply and recovering waste heat; (c) resource recycling and recovery from industrial residues to produce marketable by-products (e.g. organic fertilizers and sulfuric acid); (d) provision of energy efficiency improvement and emission reduction services with advanced and proven technologies and well-structured operations and maintenance (O&M). Table N2 summarizes the sources and estimated sizes of financial revenues for the initial subprojects, which sum up to $173.3 million per year under the designed operation periods.

1 The cost escalation factors are important for estimating the financial performance of the subprojects, because they will directly impact on (a) the inflation rates that would affect the sales revenues; (b) the operation and maintenance costs; and (c) the exchange rates that would change the domestic resource costs of serving foreign debts. The data on the cost escalation factors are adopted from two sources: from the World Bank's estimation of the International Cost Escalation Factors in terms of the Manufacture's Unit Value Index, as of 20 August 2009, for the time period between 2010 and 2020. The remaining years are simply assumed to have the same cost escalation factors as in the years between 2015 and 2020 from EARD, ADB on the PRC Domestic Cost Escalation Factors between 2010 and 2013. Constant cost escalation factors are assumed for the remaining years.

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Table N2: Financial Revenues of Subprojects

B. Project Investment and Financing Plans

Subproject investments include (i) construction expenditures for equipment, civil works, installation, monitor devices, and other expenses (e.g., design, implementation supervision, and technology transfer fees), which constitute fixed assets to be depreciated and expenses to be amortized for tax purposes; (ii) interest during implementation; (iii) financing charges (commitment and front-end fees); and (iv) working capital. There is no need for new land acquisition nor resettlement, since all subprojects will be implemented within the boundaries of subproject sponsors. As shown in Table N3, the total investment amounts to $209.5 million ($65.1 million for Golden Yimeng, $76.7 million for Lufang, and $67.7 million for SMM).

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Table N3: Project Investment and Financing Plans

Source: Subproject feasibility study reports and ADB estimates.

The subproject investment is planned to be financed from three sources: (i) 30.0% from sponsors’ own equity contribution, which is higher than the average for normal infrastructure projects; (ii) 22.2% as long-term debts from domestic banks; and (iii) 47.7% as foreign debts from ADB. As such, the whole $100 loan committed by ADB is planned to be onlent to the three initial subprojects. Subsequent subprojects under this FIL will be funded by the repayments from the initial subprojects.

The domestic and foreign debts are assumed to have a uniform tenure of 6 years, including a grace period of 2 years. The relending interest rate on the ADB loan to Shandong Province is based on the current London interbank offered rate (LIBOR) for 7-year fixed-interest swap (currently at 3.27%) plus the ADB loan spread of 0.3%. To avoid the possibility of creating market distortions, the on-lending rate from the FI to the subprojects is tied to the People’s Bank’s benchmark rate with a 10% discount that is allowed for projects encouraged by the Government and hence assumed to be 5.346. (This will leaves an interest rate gap of 1.596%, which can be used to reward subproject sponsors for achieving the targets on energy efficiency improvement and emission reduction, to cover part of the costs of the Project Management Office, the Financial Intermediary, to engage third-party professionals for validation and verification of emission outcomes, and to accumulate reserves to cope with foreign exchange risks.)

C. Weighted Average Cost of Capital

Companies normally raise money from a number of sources. Different securities are expected to generate different returns. The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average to all its security holders to finance its assets. The WACC is the minimum return that a company must earn on existing asset base to satisfy its creditors, owners, and other providers of capital. A project will not be financed if its returns on capital are less than its WACC. For all three subprojects, WACC has been calculated after tax, in real terms, using the actual capital mix and costs of funds.2 Actual interest rates of local long-term loans (with a tenure longer than 5 years) are used. The cost of equity is assumed to be 14%, based on the current financial performances of the sub-borrowers. The income tax rate is 25%, and the average domestic inflation rate is assumed to be 1.93% per year. It is clear that subprojects with relatively higher debt-equity ratios will have a lower WACC. The

2 WACC is one of the most important figures in assessing a project’s financial viability, both for internal use (in capital budgeting) and external use (valuing the project for investment decisions). Borrowers use WACC as a minimization target to optimize the project’s capital structure; investors use WACC as a hurdle rate to help decide whether a project represents a good investment opportunity.

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calculation is summarized in Table N4. For all subproject, the combined WACC is calculated to be 3.01%.

Table N4: Weighted Average Cost of Capital

D. Capital Cost, Benefits, and O&M Costs

Capital costs are based on estimated investment costs in the feasibility studies including equipment and materials, civil works, installation, monitoring devices, and other related expenses (e.g., design, implementation supervision, and technology transfer fees). Provision for physical contingencies is included as appropriate. No cost is included for land acquisition or resettlement, since all subprojects will be implemented within the existing premises of the subproject sponsors. The subproject construction period will be 2 years (2011 and 2012).

Operating costs mainly include purchased raw materials and fuel, wages and benefits, maintenance and repair, and other sales and management expenses. Net cash flows from the subprojects are determined after allowing for income taxes at 25% of incremental pretax profit.

E. Financial Performance Indicators

Table N5 provides a summary of the financial performance indicators, including financial internal rate of return (FIRR), financial net present value (FNPV), payback period, and debt service coverage ratio (DSCR) for each of the three subprojects, as well as the overall results for all three initial subprojects combined. Detailed computations of FIRRs and FNPVs are in Table N6. All the FIRRs are substantially higher than the weighted average cost of capital estimated at 3.01%. The FNPV for each subproject is calculated using the estimated weighted

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average cost of capital. The first batch subprojects are apparently financially attractive. The financial viability of the entire project was subjected to sensitivity analysis under various adverse conditions (Table N7). The sensitivity analysis indicates that the project is sensitive to change in revenues, but remains stable and robust under various adverse scenarios.

Table N5: Key Financial Performance Indicators Subprojects FIRR (%) FNPV Payback ($ million) Period DSCR (Yr) Golden Yimeng Group 23.4 148.4 4.0 1.34 Dongying Lufang Metallic Materials 22.5 104.3 3.9 1.37 Shandong Mining Machinery 20.5 62.0 3.5 1.58 Total for Batch 1 22.3 314.7 3.8 1.42 FIRR = financial internal rate of return; FNPV = financial net present value; DSCR = Debt Service Coverage Ratio Source: Subproject feasibility study reports and ADB estimates.

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Table N6: Financial Internal Rates of Return 1 2 3 4 5 6 7 8 9 10 11 12 Item 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

A.Golden Yimeng Group Cash Inflow 0.0 0.0 140.2 145.9 151.7 157.8 164.1 170.6 177.4 184.5 191.9 199.6 Cash Outflow 211.9 213.5 31.2 38.9 42.4 46.0 49.8 52.7 55.7 58.9 62.3 65.9 Capital costs 211.9 213.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Operating expenses 0.0 0.0 16.4 17.6 18.9 20.3 21.8 23.4 25.2 27.1 29.1 31.4 Corporate income tax 0.0 0.0 14.8 21.3 23.5 25.7 28.0 29.3 30.5 31.8 33.1 34.5 Net cash inflow after income tax -211.9 -213.5 109.0 107.1 109.4 111.8 114.3 118.0 121.8 125.6 129.6 133.7

After tax FIRR (%) 23.4% FNPV (CNY million) 1,009.3 FNPV ($ million) 148.4

B.Dongying Lufang Metallic Materials Cash Inflow 0.0 0.0 218.5 283.1 293.7 304.7 316.2 328.1 340.6 353.5 366.9 380.9 Cash Outflow 171.9 335.1 104.3 143.4 151.3 159.6 168.2 175.8 183.8 192.2 201.0 210.1 Capital costs 171.9 335.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Operating expenses 0.0 0.0 92.5 115.7 121.0 126.6 132.4 138.6 145.1 152.0 159.2 166.8 Corporate income tax 0.0 0.0 11.9 27.8 30.4 33.0 35.8 37.2 38.7 40.2 41.8 43.4 Net cash inflow after income tax -171.9 -335.1 114.1 139.6 142.3 145.1 148.0 152.3 156.7 161.3 166.0 170.7

After tax FIRR (%) 22.5% FNPV (CNY million) 709.4 FNPV ($ million) 104.3

C.Shandong Mining Machinery Group Cash Inflow 0.0 0.0 746.1 772.8 800.5 829.4 859.5 890.7 923.2 478.5 Cash Outflow 280.3 154.3 613.5 642.8 668.3 694.8 722.3 749.8 778.4 418.6 Capital costs 280.3 154.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Operating expenses 0.0 0.0 599.7 622.1 645.4 669.7 694.9 721.2 748.5 407.9 Corporate income tax 0.0 0.0 13.8 20.7 22.9 25.1 27.4 28.6 29.9 10.8 Net cash inflow after income tax -280.3 -154.3 132.5 130.0 132.2 134.6 137.1 140.9 144.8 59.8

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After tax FIRR (%) 20.5% FNPV (CNY million) 421.6 FNPV ($ million) 62.0

D. All Subprojects Cash Inflow 0.0 0.0 1104.8 1201.7 1246.0 1291.9 1339.8 1389.5 1441.2 1016.5 558.8 580.4 Cash Outflow 664.1 702.8 749.1 825.1 862.0 900.4 940.4 978.3 1017.9 669.7 263.2 276.0 Capital costs 664.1 702.8 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Operating expenses 0.0 0.0 708.6 755.4 785.3 816.5 849.2 883.2 918.8 586.9 188.3 198.1 Corporate income tax 0.0 0.0 40.5 69.7 76.7 83.9 91.2 95.1 99.2 82.8 74.9 77.9 Net cash inflow after income tax -664.1 -702.8 355.7 376.7 384.0 391.5 399.4 411.2 423.3 346.8 295.6 304.4

After Tax FIRR (%) 22.3% FNPV (CNY million) 2,140.3 FNPV ($ million) 314.7 ( ) = negative, FIRR = financial internal rate of return, FNPV= financial net present value. Note: Cash flows shown are only for the first 12 years; financial internal rate of return calculation considered the economic life of the investment. Source: Asian Development Bank estimates.

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F. Sensitivity Analysis and Financial Robustness

The financial viability of the whole Project has been stress-tested under various adverse conditions, using sensitivity and scenario analysis tools. As shown in Table N7, the Project remain stable and robust under various adverse scenarios.

Table N7: Sensitivity Analysis of Financial Performance Indicators Case Change FIRR (%) SI SV A. Base Case 22.3 B. Sensitivity Cases 1. Capital cost overrun 10% 19.9 1.7 60.0 2. Lower benefits 10% 13.9 5.8 17.1 3. Implementation delay 1 year 19.1 4. Combination of (i),(ii), and (iii) 10.5 FIRR = financial internal rate of return, SI = sensitivity indicator, SV = switching value. Notes: Sensitivity indicator is the ratio of percentage change in the FIRR divided by the percentage change in the given parameter. Switching value is the percentage change in a parameter for the project decision to change, that is, for the net present value to become zero or the FIRR to fall to the cut-off rate. Source: Asia Development Bank estimates.

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APPENDIX O: SOCIAL AND POVERTY ANALYSIS

A. Introduction

The goal of social and poverty analysis of the three initial subprojects is to identify the socio-economic impacts on the welfare and livelihood of beneficiaries, particularly on reducing the number of people in poverty in project areas. This review describes the social situation, poverty and ethnic minority situation in Shandong Province and analyses the social impact, poverty impact and gender impact, as well as social benefits. The analysis has been undertaken in line with ADB guidelines on social dimensions, gender, and poverty reduction, minorities and safeguard issues. It can also be used as a template for the social analysis of future subprojects under the Shandong EE&ER Project.

B. Socio-economic Overview of the Project Areas

Shandong Province comprises 17 municipalities and 139 counties, districts, and cities spread over 156,700 square kilometers with a population of 94.17 million in 2008. Its gross domestic product (GDP) has grown at more than 10% per annum since 1995, significantly higher than the national average. Its GDP was CNY3.1 trillion in 2008, representing approximately 11% of the nation’s total GDP. The GDP of CNY0.3 trillion is attributed to primary industry, CNY1.77 trillion to secondary industry, and CNY1.04 trillion to tertiary industry. The ratio of these three industries is 9.66: 56.97: 33.37. The output value of heavy industry was over 65% of the total industrial output. This suggests that economic development in Shandong Province is closely related to heavy industry. In particular, the province is a key center in the PRC of manufacturing for ferrous and metal products, special purpose machinery, transport equipment, and electrical machinery; and the annual growth rate of manufacturing has consistently been above 20% since 2003. The initial subprojects are distributed in three cities in Shandong: Dongying, Yantai and Linyi. The combined GDP of the three cities accounts for 23.9% of the total GDP of Shandong province. Per capita GDP in Dongying and Yantai reaches 83,658 CNY/person in 2009, 41,160 CNY/person higher than the provincial level; but that in Linyi is substantially lower than the provincial average level, only 16,956 CNY/person.

The growth of energy demand in Shandong Province has kept pace with the rapid expansion of the economy and expediting the process of industrialization. Energy consumption was approximately 68.9 million tons of standard coal equivalent (Mtcse) in 2000 and increased to 216 Mtsce in 2008, with an average annual growth rate of approximately 13.5%. The primary energy demand is met predominantly by coal (77%) and oil (21.2%). Over one-third of the total final energy consumption in Shandong was directly from coal. As well, some 99% of the generation capacity in the province is

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from coal-fired power plants, which have been the major contributor to air pollution. Approximately, 48% of the cities fail to meet the national air quality standards; and since 2000, most of Shandong Province’s large cities have had an increase in the number of days when the ambient air quality failed to meet national air quality standards. The province’s annual sulfur dioxide (SO2) emission ranged from 1.69 Mt to 2 Mt from 2000 to 2008. In 2008, Shandong Province was the largest emitter of SO2 among the provinces, accounting for 7.5% of the total SO2 emissions in the country. Approximately, 10% of nitrogen oxides (NOx) emissions and 8% of carbon dioxide emissions of total PRC emissions are estimated to originate in Shandong Province. Over one-third of the province experienced acid rain in 2008, which is caused primarily by SO2 and NOx pollution.

The natural population growth rate in Shandong Province was 5.5‰, 0.08‰ point lower than the national average level. The provincial urban population was 34.36 million, accounting for 36.6% of the provincial total population. The subprojects are distributed in three cities of Shandong Province: Linyi, Dongying and Yantai (Changle County). There are great differences in the three municipal populations. The population in Linyi is more than 9 million and in Yantai is nearly 7 million, but in Dongiyng is only 1.99 million. The natural population growth rate in Yantai is quite low, only 0.44‰, but that in Dongiyng is highest, at 4.82‰. The proportion of urban population in total population in Dongying and Yantai is 39.6% and 42.9% respectively, higher than the provincial level and lower than the national level. That of Linyi is only 21.5%.

C. Ethnic Minorities and Gender Analyses

There are 53 ethnic minorities in Shandong but the total population is very small with only 0.5 million, accounting for 0.6% of the total provincial population, in which Hui minorities account for 90% of the minority population. As all subprojects will be selected in industrialized areas, where no indigenous peoples reside, there are few minority populations around the subproject sites, the impacts on minority are minimal. In terms of the EE&ER, the impacts on surrounding persons should be positive.

In Shandong, the total female population is over 46 million, accounting for 49.8% of the total population, which is slightly higher than the national average level. Women make up a higher proportion of the population in Linyi (at 51.2%) than in Dongying and Yantai, (45.2% and 46.3%, respectively). The initial three subprojects will provide employment opportunities for women and promote their long-term development. There are appropriate covenants for equal employment opportunities for women, equal pay for equal work, and prohibition of child labor are proposed in the project agreement.

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D. Subproject Social Impact Analysis

All subprojects will be limited to retrofitting and optimizing energy-inefficient and pollution-intensive equipments and systems to improve energy efficiency and reduce pollution emissions. Hence, the project does not entail any permanent land acquisition, temporary land occupation, restriction of land access, or demolition of residential housing. The subject projects proposed by Lufang and Golden Yimeng would be constructed within the existing facility and would not involve land acquisition. SMM’s initial coal washing projects proposed would be all located within client sites and hence do not require land acquisition. Any future subprojects that involve land acquisition or resettlement issues will not be considered under this Shandong EE&ER project. Therefore, no land acquisition or resettlement plan is needed.

The three subprojects would not result in workforce redundancy. They not only help maintain present employment under the current operation of the enterprises but create new employment opportunities instead. Hence, the proposed project will not trigger any social safeguard policies. In particular, the project is expected to achieve a positive social impact in the project areas and Shandong in general. As discussed in Appendix E, the subproject will result in energy savings and GHG emission reduction. The Project will have a positive social impact by increasing the coverage of energy supply, reducing air pollution, avoiding other environmental damages associated with coal use; as such, the Project will improve the quality of life for people in the project areas.

As indicated in Table O1, the three subprojects will create approximately 320 short-term jobs during the construction stage, which will include installation, infrastructure construction, and so on. Rural workers will account for about 30% of the 320 positions. As the construction period is not long, usually 12-18 months, the construction workers may receive an average income of 4,500 CNY/person.

Table O1: Income and Employment Opportunities Created During Construction

Subproject Employment Opportunities Daily Wage Income (persons) (CNY/person-day) (CNY/person)

Golden Yimeng 80 100 54,000

Lufang 40 100 36,000

SMM 200 100 36,000

Total 320 100 42,000

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As indicated in Table O2, once operational, the three subprojects will create a total of 440 long-term jobs needed for operation, maintenance and management of the EE&ER systems. Their wage levels of these new positions would be the same as the existing factory workers.

Table O2: Employment Opportunities Created During Operation

Subproject Employment Opportunities (persons) Annual Income (CNY/person)

Golden Yimeng 200 36,000

Lufang 60 36,000

SMM. 180 40,000

Total 440 36,545

E. Public Consultation

Public consultation was undertaken during the project preparation.

(1) Consultation with central government agencies. The National Development and Reform Commission, Ministry of Finance, Ministry of Industries and Information Technologies, and Ministry of Environmental Protection have been consulted to ensure the project is aligned with the government's development strategies and priorities;

(2) Consultation with provincial government agencies. The Shandong provincial government will be the executing agency for the project. Shandong Provincial Development and Reform Commission, Shandong Provincial Finance Department, Shandong Economic and Information Technology Commission, and Shandong Provincial Department of Environmental Protection are the partners for the project, and have been participating in all steps for the project design and subproject selection. They are also the main constituent entities of the project management office. Shandong Provincial Energy Conservation and Monitoring Center has been active in providing support for the preparation of the subprojects;

(3) Nongovernment and private organizations. Experts from industrial associations and research institutions have been invited to workshops or engaged as advisors for the project. Interviews and site visits were conducted with more than 20 large energy consuming enterprises, energy service companies, and high-efficiency equipment manufacturers; and

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(4) Local communities. Consultations were conducted to gauge support for the project from local communities, which will be direct beneficiary groups.

F. Poverty Analysis

The definition of “poverty” changes several times in the past decade. In 2005, according to rural residents living consuming price index, the national rural absolute poor population living standard was adjusted from 668 CNY to 683 CNY per capita income by the National Statistics Bureau while the national low-income population standards was adjusted from 924 CNY to 944 CNY per capita income. As a well developed province, Shandong Province set its own standards higher than the national standards. The provincial absolute poverty standard is 1,000 CNY per capita income and low-income population standard between 1,000 CNY and 1,500CNY per capita income, depending on the regions in the province. At present, the number of national key poverty alleviation counties in Shandong is zero. The poor ratio is 14.3% in the Project areas. The poor population distribution is shown in Table O3.

Table O3: Poverty Population Distribution in Project Areas in 2007 (10,000 persons)

Absolute National Low Provincial Provincial Low Total Poverty Location Poverty Income Poverty Income Population Population Population Population Population

China 5,700 2148 3,550

Shandong 907 178 278 629

Projects Areas 269.9 65 113.9 156

Linyi 176 49 78 98

Dongying 24 4 8 16

Yantai 69.9 12 27.9 42 Data source: Internet and confirmed by provincial office.

As a result of the three subprojects, at a discount rate of 12%, the economy will gain total CNY142.2 million from income taxes (see Table O4). Workers will gain CNY156.9 million because the Project pays wages in excess of the economic opportunity cost of labor. Consumers will gain CNY1255.5 million because they can avail themselves of increased benefits at a lower cost than without the Project. The share of net economic benefits of the Project accruing to the poor is 16.54%. Since the ratio is higher than 14.3% of the poverty ratio in the project area, the analysis concludes that the Project will support pro-poor economic growth. The share of

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16.54% does not include indirect environmental benefits of the Project. In addition, it will reduce coal consumption, free up resources, and lower the worker safety risks associated with coal mining and transportation.

Table O4: Distribution of Project Benefits and Poverty Impacts (CNY million) Items Accounts Beneficiaries A. Distribution of People Financial Economic Difference Government Project Corporation around Labor Total Accounts Accounts /Economy Benefits Projects Benefits Out 4576.3 5945.2 1368.9 1368.9 Environmental 1255.5 1255.5 1255.5 Benefits Total Benefits 4576.3 7200.7 2624.4 Costs Investment Costs 913.7 931.4 17.7 (17.7) O & M 2893.8 4482.5 1588.7 (1588.7) Labor 239.6 82.7 (156.9) 156.9 Taxes 379.7 0.0 (379.7) 379.7 Total Costs 4426.8 5496.6 1069.8 Net Benefits 149.5 1704.0 1554.6 149.5 1255.5 142.2 156.9 1704.0 B. Poverty Impact

Beneficiaries in 1255.5 142.2 156.91704.0 Financial and Economic Accounts Net Financial Benefits 149.5 149.5 Total 1255.5 142.2 156.91853.5 Proportion of Poor 0.2 0.2 0.2 Benefits to Poor 251.1 24.2 31.4 306.7 Poverty Impact Ratio 16.54%

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