Report No. PID5674 Project Name China - Hunan Power Development Project (@) Region East Asia and Pacific Sector Energy and Mining Development Public Disclosure Authorized Project ID CN-PE-35698 Borrower People's Republic of China Implementing Agency Hunan Electric Power Company (HEPC) Mr. Yu Xingqiang 64 Shaoshan Road, Changsha Hunan 410007, People's Republic of China Tel: 86-731-554-3115 Fax: 86-731-554-3182 Date PID Updated March 24, 1998 Indicative Schedule: Public Disclosure Authorized Project Preparation October 1997 Pre-appraisal January 1998 Appraisal March 1998 Negotiation May 1998 Board Presentation June 1998 Sector and Institutional Background 1. Large-scale energy development and improvements in the efficiency of energy supply and use are critical to meet the fast growing demand, alleviate shortages and mitigate adverse impacts on the environment in China. China has experienced an annual growth rate of about 8.3 percent in installed capacity and energy generated in the period 1980-95. To meet the electricity demand in Public Disclosure Authorized the most cost-effective manner, the Government is implementing a comprehensive strategy of sectorwide institutional reforms, energy price reforms, and encouraging energy conservation. Consumer prices for the major forms of energy now largely reflect economic costs. A well-developed institutional network exists to promote energy conservation at the central, provincial and local levels. These measures have helped China achieve a remarkably low 0.86 elasticity demand growth to GDP growth during 1980-95. 2. Yet even with further improvements in conservation, generation capacity must increase by about 15 GW a year for the next five years if current shortages are not to become more acute. For continued efficiency improvements -- not simply in energy use but in the overall functioning of the sector -- and for the increased capital mobilization necessary for large-scale power industry development, China has launched an ambitious program of power sector reforms. Thus far, progress has been made in sector decentralization, cost recovery through major tariff reforms, and diversification of financing Public Disclosure Authorized sources, including development of a variety of independent power generation schemes. In the gradual process of legal reform and sector restructuring, three important steps have recently been taken, with passage of the country's first Electricity Law, a decision to abolish the Ministry of Electric Power and divide its functions among existing government agencies, and a further decision to create a State Power Corporation to, inter alia, represent the state as owner of government-owned power assets. Furthermore, several joint venture companies have been established to build power plants in Shandong Province and Shanghai, while build, operate, transfer (BOT) schemes have been introduced in Guangdong and Fujian Provinces. The process of international competitive tendering for projects has also begun with the Laibin B project in Guangxi Zhuang Autonomous Region, which will be constructed by an international consortium, and bids are being evaluated for Changsha power project in Hunan Province. 3. Building on these accomplishments, the Government's future agenda for action includes: (a) further reforms to the sector's regulatory and legal framework; (b) further diversification in financing for power development, including private sector participation; (c) institutional restructuring via commercialization and corporatization of power companies, together with achievement of greater enterprise autonomy and sector restructuring; and (d) further measures to rationalize power tariffs. While actions have been initiated on all of the above fronts, measures to commercialize the power entities are now a focal point in the overall effort. These measures include separating the producing entities from the Government, granting them autonomy in business decision-making, and subjecting them to market forces in an arms- length regulatory framework. 4. The Chinese approach to reform encourages experimentation with different reform options and institutional forms. This gradual approach permits the Chinese to examine the relevance and applicability of specific reforms and also to fine-tune reform implementation for broader dissemination or replication in other parts of the country. 5. Accompanying the move to commercialization are efforts to curb air pollution related to the burning of coal and particularly to reduce the power sector's contribution to the problem. In terms of emission control in large and medium-scale plants, China has made substantial progress in particulate control, through deployment of high efficiency electrostatic precipitators. The Government announced in June 1994 that it would spend about $2 billion over the next seven years on an environmental program aimed at keeping S02 emissions at a level of 15 million metric tons a year, as part of a comprehensive program of acid rain abatement. The Government intends also to accelerate the development of hydropower and construction of large and efficient 300 and 600 MW coal-fired units to avoid the mushrooming of the small, highly polluting plants that still constitute about 60 percent of the additional installed capacity. The Hunan Power Grid - Area of Project Impact 6. Hunan province, where the proposed project is located, is the seventh- most populous province in China with a population of 63.5 million at the end of 1995. It is bordered by Sichuan and Guizhou in the west, Guangxi and Guangdong in the south, Jiangxi in the east, and Hubei in the north. Although it has abundant nonferrous mineral resources and is China's lead rice producer, Hunan remains one of the country's poorest provinces. In 1995, its per capita gross domestic product (GDP) was 3,456 Yuan, about 28 percent lower than the national average. The province was nevertheless experiencing impressive growth in the past five years. From 1990 to 1995, the average annual growth rate of GDP of the province was 12 percent. For the same period, the average annual growth rate of energy consumption was 8.98 percent. The peak demand in 2005 is expected to be around 12,700 MW and demand for -2 - energy generation 69.8 TWh based on an annual average growth rate of 8.4 W and 7.7 ', respectively. 7. The Hunan Power Grid (HPG) is an important part of the Central China Grid (CCG), located in the south of the Central China Grid. CCG covers Henan, Hubei, Jiangxi, and Hunan Provinces. HPG is connected with CCG through two transmission lines, one 500 kV line to Gezhouba hydro power station and one 220 kV line to Fengfanshan substation in Wuhan, Hubei. 8. By the end of 1995, HPG had a total installed generating capacity of 7,755.5 MW, of which 3,544.2 MW coal-based (45.7%) and 4,211.3 MW of hydropower (54.3%). The peak load was 5,554 MW and the total electricity supply (including energy exchanges) was 33,934 GWh. The net power import from other provinces was 890 GWh. Electricity consumption per capita was 530 kWh, about 65.6 percent of the national average. The provincial power sector is plagued by acute power shortages: in 1995, load was shed (35kV and above switches) about 3,968 times. The minimum daily load was about 70 percent of the maximum daily load, much higher than the ratio of 50-60 percent in developed countries. This indicates important load shedding and suppressed demand in the system. Shortages were estimated at about 3,000 GWh in 1995. Moreover, the elasticity of electricity consumption growth relative to GDP growth in Hunan was only 0.84 from 1991 to 1995, an exceptionally low elasticity which is not sustainable to support the economic development in the province. 9. To remedy the situation, Hunan needs to (i) accelerate the installed capacity for both peak and base loads to ensure sufficient and reliable electricity supply for the anticipated economic growth; (ii) construct large size and high efficient coal-fired power plants to improve the system's capacity during the dry season; (iii) construct mine mouth power plants to take advantage of the rich and cheap anthracite resources in Hunan and reduce the pressure on the overburdened railway system; (iv) retrofit the small thermal units or replacing them by larger, more efficient, and less polluting plants; and (v) optimize harnessing of the hydropower resources to ensure an environmentally sustainable development of the power sector. 10. The transmission system in 1995 has a total length of 13,373 km, consisting of 669 km of 500 kV lines, 4,653 km of 220 kV lines, and 8,051 km of 110 kV lines. HEPC owns and operates almost the whole transmission system. The system also includes transformer substations, with a total capacity of 22,083 MVA. 11. The existing transmission network is experiencing problems of reduced reliability, overloading of major substations and lines, and higher fault levels at 220 kV systems exceeding the permitted safe operating ranges. These problems are mainly caused by an inadequate investment in the transmission systems required to transmit the new production to load centers. Most generation projects only have enough transmission capacity to connect the plant to the nearest point on the system. Reinforcement of the core transmission system is urgently required Project Development Objectives and Description 12. The Project's development objective is to remedy power shortages in Hunan by providing efficient, reliable, and environmentally sound power supply. This project also supports the Country Assistance Strategy for China to alleviate infrastructure bottlenecks in an interior province to foster integrated economic development in Hunan. The Project objective would be achieved by: (a) development of two 300 MW anthracite-fired generating units at the Leiyang Power Plant to alleviate power shortage, improve the generation mix in a system dominated by seasonal hydro power, and facilitate the retirement of -3 - about 10 small, aging, inefficient, and polluting generating units in the provincial power grid; (b) reinforcement of the existing 220 kV transmission systems - supply and installation of about 794 km of 220 kV lines and 1,920 MVA of transformer substations capacity.