PROPOSAL FOR REVIEW
PROJECT TITLE: CHINA: EFFICIENT INDUSTRIAL BOILERS
GEF FOCAL AREA: Climate Change
GEF ELIGIBILITY: China ratified the FCCC on January 5, 1993
TOTAL PROJECT COSTS: $101 million
GEF FINANCING: $32.8 million
COUNTERPART FINANCING OF GEF COMPONENTS: $68 million
COFINANCING/PARALLEL FINANCING: not applicable
| Total Financing | $675 million |
| Municipal Gov't | 35 |
| Enterprises | 188 |
| Banks | 252 |
| IBRD | 200 |
GEF OPERATIONAL FOCAL POINT: GEF Operations Committee, Ministry of Finance
GEF IMPLEMENTING AGENCY: The World Bank
EXECUTING AGENCY: Chinese Ministry of Machinery Industry
LOCAL COUNTERPART AGENCY: not applicable
ESTIMATED APPROVAL DATE January 1997
PROJECT DURATION: 6 years
GEF PREPARATION COSTS: GEF PDF Block C, $746,000 (April 1995)
COUNTRY/SECTOR BACKGROUND
1. Scientific evidence is mounting that a buildup in atmospheric concentrations of greenhouse gases (GHGs), especially from fossil fuel consumption, is contributing to a warming of the Earth's atmosphere. In China, energy consumption accounts for roughly three-quarters of the country's GHG emissions, the largest single source of which is coal combustion in industrial boilers. Medium and small-scale "industrial" boilers -- defined as boilers which produce less than 65 tons of steam per hour (tph) -- consumed over 350 million tons of coal in China in 1990, accounting for around 35% of the country's coal use and around 30% of GHG emissions from energy consumption. By contrast, power sector boilers consumed about 250 million tons of coal in 1990, accounting for one-quarter of total coal use.
2. Although economically rational given the country's dependence on coal, China's continuing reliance on small coal-fired boilers for industrial, commercial, and residential use is unique among large countries. There are an estimated 430,000 such boilers in use in China today and unit sizes are small by international standards; 90% produce less than 6 tph. While the average size of industrial boilers in China will likely increase as the scale of industrial production expands, the use of small and medium-scale boilers will continue to dominate China's boiler market for the foreseeable future. In contrast to other major industrial countries, where small and medium-sized industrial boilers rely primarily on oil or natural gas, and small coal-fired boilers have been largely phased out, over 95% of industrial boilers in China burn coal. Given the cost advantages of coal relative to oil, and the lack of large-scale supplies of gas in China, the use of coal in relatively small boilers will continue well into the next century.
3. Chinese industrial boiler designs and production methods are based on principles typical of those used in developed countries before 1950. Typical efficiency levels for Chinese coal-fired industrial boilers lie in the range of 60-65%. Boilers of similar scale and application in developed countries rarely operate below 80% net efficiency. In developed countries, significant improvements have been made in the technology to minimize both the exit gas temperature and excess air, which has resulted in a significant increase in the thermal efficiency of small and medium-sized boilers over the past forty years. If boiler operating efficiency levels in China were brought into line with those of similar sizes in the developed countries, current coal consumption could be reduced by around 70 million tons per annum--a savings of nearly 20%.
4. The desirability of improving the energy efficiency of industrial boilers is recognized by both engineers and policymakers in China, however, a variety of factors have prevented improvements from being realized. The current boiler production base was built up over a thirty-year period when the economy was characterized by command-and-control, artificially low prices of coal, and a primary focus among enterprises on meeting or exceeding production quotas. The economic environment in which the boiler industry now operates has changed significantly with the shift towards a market economy: (a) firms now have a profit incentive, (b) coal pricing is largely market-driven, and (c) environmental regulations have become increasingly more strict. Yet, compared to many other industries, the inertia of past practices and familiar product lines has been particularly difficult to overcome in the industrial boiler subsector.
BARRIERS TO THE ADOPTION OF ENERGY EFFICIENT BOILERS
5. Despite major advances in boiler technology worldwide over the past forty years, China's industrial boiler industry has operated largely in isolation from the world market. Since 1980, major international companies have shown considerable interest in China's large-scale electric power boiler sector, and to a lesser extent in medium-sized oil and gas-fired boilers, however, there has been a striking absence of interest in small and medium-scale coal-fired boilers. Among the reasons for the lack of foreign interest include: (a) profit margins for international firms are low compared to those in the power boiler market, (b) development is likely to occur over a long period of time and be characterized by adaptation and integration rather than sales of "off-the-shelf" components or package boilers, (c) unlike in the power boiler market, improved small-scale boiler designs could be easily replicated and disseminated, thus forfeiting the ability to recoup development and investment costs, (d) the few international firms that continue to produce small-scale coal-fired boilers are mostly small companies, and their involvement in the China market would be risky as well as costly, and (e) there is little export potential for small coal-fired boilers, and thus an inability to directly earn foreign exchange.
6. While the lack of access to advanced international technologies is a major impediment to energy efficiency (and pollution control) improvements in China's industrial boiler market, there are numerous domestic barriers as well on both the producer and consumer side: (a) the industry remains highly fragmented, with about two dozen major producers and hundreds of smaller ones, resulting in insufficient scale economies for new product development initiatives; (b) product marketing capabilities and customer service, basically non-existent under the planned economy, are still weak, which has inhibited the introduction of new boiler models; (c) excess production capacity (albeit for low-quality boilers) has resulted in low industry profits for a number of years, contributing to a shortage of funds for new investment; (d) efficiency, coal quality, and environmental standards for industrial boilers are outdated, and enforcement at the local level is difficult without clear technical solutions; (e) the disintegration of central information systems, decentralized production, and weak industry associations have resulted in a scarcity of information exchange, particularly of a commercial nature, within the industry; (f) low profitability, and intense competition in the small, low-technology part of the industry, has inhibited the development and marketing of boilers with higher acquisition prices; (g) technology development resources and quality staff have been drawn disproportionately to other engineering and technical fields, such as the large power boiler industry; (h) the lack of consumer information on energy savings of major capital equipment has inhibited the purchase of more efficient but higher-priced boilers; (i) consumers have shown a disinterest in purchasing new energy-efficient boiler models unless there are other significant benefits, such as reduced local pollution emissions, ease of use, and increased safety; and (j) underdeveloped capital markets have been reluctant to lend to producers for domestically untested new products or to consumers for capital investments with payback periods of more than a few years.
7. As a result of these factors, energy efficiency improvements in coal-fired industrial boilers in China over the past decade have been very modest, with minimal investment in product development and production line overhaul. A recent study of China's boiler industry, carried out as part of the GEF-supported China Greenhouse Gas Study, concludes that major improvements in the energy efficiency of Chinese boiler designs can be achieved only through a systematic program of acquiring and demonstrating advanced international technologies in China, and removing the barriers to widespread dissemination.
ENVIRONMENTAL POLICY FRAMEWORK
8. Over the past decade, China has taken significant steps in establishing environmental policies and an environmental regulatory system. The National Environmental Protection Agency (NEPA) oversees national environmental policy, works with the environmental protection units within the ministries and state enterprises, and sets the overall policies and regulations governing provincial and municipal environmental protection bureaus. Although comprehensive laws, regulations and standards for most pollutants (including TSP and SO2) have been in place in China for many years, enforcement of these laws and standards at the local level, where the bulk of environmental policy takes place, remains a difficult challenge. Providing local environmental protection bureaus with a partial technical answer in the form of cleaner and more efficient boilers would be an important step in strengthening environmental compliance.
9. A national-level Climate Change Coordination Group was created in February 1990 and charged with overall policy formulation on the greenhouse gas issue. Several climate change mitigation studies have been completed by the Government of China, including one supported by the GEF. The GEF-financed study, which involved a comprehensive analysis of GHG abatement options in China and their relative costs, concludes that improving industrial boilers through technology transfer and demonstration offers the greatest potential for reducing large amounts of CO2 in China in a very low-cost way.
GEF PROJECT OBJECTIVES
10. The principal objective of the GEF project is to improve the energy efficiency of small and medium-scale coal-fired industrial boilers in China by acquiring foreign advanced technologies, adapting them to Chinese conditions, and broadly disseminating the results throughout China. Enterprises participating in the project will account for approximately 20% of total industrial boiler output over the next 20 years, and perhaps 50-60% including indirect effects. Additional objectives include: (a) upgrading China's industrial boiler engineering, production management, operator training, and service and marketing capabilities; (b) strengthening the domestic exchange of information on high-efficiency industrial boiler technologies and commercial experience, and; (c) improving efficiency, coal quality, and environmental standards and regulatory enforcement for the industrial boiler sector.
GEF PROJECT DESCRIPTION
11. Chinese industrial boiler production capabilities would be upgraded through the introduction of advanced international technologies for existing and new boiler models. The project would also include activities aimed at removing barriers to the widespread dissemination and adoption of energy efficient boilers.
PROJECT DESIGN
12. The project is designed to give Chinese boiler enterprises full scope in proposing efficient boiler production solutions in the context of an open, fair, and competitive bidding process. In this way, the project is extremely novel and innovative compared to attempts in other industries to introduce advanced technology through a centralized top-down approach. Domestic enterprise groups (consortia of boiler manufacturers, engineering and design firms, and auxiliary manufacturers) will be selected based on their ability to meet predetermined performance objectives (including energy efficiency and environmental objectives), their technical capabilities, the financial soundness of the lead enterprise and the project proposal, and the ability of the group to arrange domestic counterpart financing. Potential foreign technology suppliers have been pre-qualified based on their ability and willingness to transfer technology for nine boiler technological packages identified during pre-feasibility.
13. Boiler development and dissemination will proceed in two phases. Phase One will include technology development and demonstration and will involve: (a) procurement of foreign technology from international equipment suppliers and engineering services firms, followed by; (b) the design, manufacture, testing, and evaluation of prototype boiler models, undertaken jointly by international experts and engineers and Chinese boiler manufacturing and design enterprises. Phase Two will include: (a) full-scale production and mass marketing of advanced designs by project enterprises; (b) industry awareness campaigns and dissemination of advanced designs to boiler producers, consumers, design institutes, and regulatory agencies, and; (c) cooperation with local government agencies on devising incentives and regulatory schemes to achieve broad adoption. The high-efficiency boiler development center will be critical to the success of Phase Two.
ASSOCIATED INVESTMENT PROJECT
14. The GEF Efficient Industrial Boilers project is associated with the Chongqing Industrial Pollution Control and Reform Project. The Chongqing Project proposes to assist the Municipal Government (CMG): (a) achieve a major reduction in pollution from one of its most polluting industries, iron and steel, by funding the relocation of two highly polluting facilities, (b) initiate a pilot effort and line-of-credit facility to assist enterprises in other industrial sub-sectors to control pollution and restructure their production facilities; (c) establish a strategy and prepare a long-term plan to reduce industrial pollution; and (d) provide technical assistance to increase the effectiveness of environmental regulation, monitoring, and pollution management by the Chongqing Environmental Protection Bureau.
15. Chongqing, which has some of the highest ambient concentrations of sulfur dioxide in the world, can significantly reduce both sulfur and particulate emissions through the adoption of more energy efficient and cleaner industrial boilers. According to CMG, small and medium-sized industrial boilers account for as much as half of the municipality's coal consumption and associated air pollution. The GEF Efficient Industrial Boilers Project will complement the Chongqing Project by seeking to improve the production and supply of high-efficiency and cleaner boilers, and by working with the Chongqing Government in enforcing environmental standards for boiler emissions in industrial enterprises. More specifically:
PROJECT COST AND FINANCING
16. Preliminary investment cost estimates for the GEF project are US$101 million, with details provided in the table on page 12. An estimated $68 million equivalent would be provided through local counterpart funding, consisting primarily of enterprises' own funds and commercial bank loans; the typical way of financing energy efficiency investments in China. The remaining balance of approximately $33 million for the project is sought from the Global Environment Trust Fund to finance incremental costs.
INCREMENTAL COSTS
17. The incremental cost of the project is calculated as the difference between the costs of the "GEF alternative" in supplying steam and hot water from industrial boilers, and the costs that would be incurred using existing similarly-sized lower-efficiency boilers ("baseline"). Details of the incremental cost calculations are given in Annex 1.
18. In a world of perfect information, zero risk and uncertainty, fully-functioning markets over space and time, and no other transaction costs, the GEF alternative would have a negative incremental cost; i.e., the discounted energy savings over the life of all improved boilers would be sufficient to cover the higher costs of production, including technology transfer. Calculations of the theoretical economic incremental cost are provided in Annex 1. The fact remains that there have been only limited improvements in the energy efficiency of Chinese industrial boilers over the past fifteen years, despite the fact that most enterprises in China now pay market prices for energy. In addition to the barriers described above (paras. 5-6), the overall GEF project is inhibited by a time lag of 12 years between investment cost outlays by boiler producers and a payback in benefits from fuel savings accruing to boiler consumers.
19. The more realistic incremental cost is that faced by boiler producers to acquire advanced boiler technologies from abroad (licensing, procurement of engineering services, and selected purchase of embodied technology), adaptation, and commercial demonstration. Additional costs to boiler producers include the modification of production facilities, the training of technicians in production, installation, and operation of the new models, and upgrading marketing and service capabilities. For boiler producers, the (discounted) baseline cost of producing 364,000 tph of capacity over twenty years has been estimated at $1,584 million, while the GEF alternative has a total cost to producers of $1,862 million; a difference of $278 million (see Annex 1). Producers also receive different income streams under the baseline and GEF alternative due to higher sales prices of the improved boilers. The additional (discounted) income received by producers of improved boilers under the GEF alternative is estimated at $248 million. After subtracting the benefits from costs to producers, there is a net incremental cost of approximately $30.2 million for boiler producers for undertaking the GEF alternative. Additional costs of the GEF alternative are: (a) for overcoming the barriers to the broad dissemination of the advanced boilers throughout China, and include improving public awareness of energy efficiency and pollution control in the industrial boiler sector, and disseminating technical and commercial information on the efficient boilers, estimated at $1.5 million, and (b) the costs of monitoring and evaluation and project support, estimated at $1.135 million. The costs of technology transfer and other incremental costs of the subprojects will be updated at project appraisal, after the winning proposals have been selected. Additional details on the barrier removal and M&E components will also be finalized at project appraisal.
Expense Categories (US$ '000) Upgrading Existing Boiler Designs 15,980 Technology licenses 2,900 Engineering services 4,450 Embodied technology 6,710 Contingencies 1,920 Adoption of New Boiler Designs 14,220 Technology transfer licenses 4,370 Engineering services 3,960 Embodied technology 3,940 Contingencies 1,950 Training (manufacturers, consumers, operators, regulators) 1,000 Marketing and Dissemination 150 Technical and Policy Studies 350 Monitoring and Evaluation 340 Project Support 795 TOTAL 32,835
PROJECT SUSTAINABILITY
20. The sustainability of the project depends on the appropriateness of the technology and the ability of local experts and institutions to adapt and disseminate the technology. Accordingly, the project emphasizes: (a) involvement of large numbers of leading Chinese engineers working in joint teams with foreign experts in the process of identifying, evaluating, acquiring and adapting technological improvements, (b) selection through competitive bidding of leading and well-established domestic boiler manufacturing enterprises for the design, demonstration, and production phases, (c) assistance in product marketing, customer service, public awareness, and broad dissemination of demonstration results, and (d) working with national and in particular local planning and environmental authorities to ensure that effective incentives (including environmental and energy efficiency standards) are provided for the adoption of cleaner and more efficient boiler designs.
RATIONALE FOR GEF FUNDING
21. China ratified the U.N. Framework Convention on Climate Change on January 5, 1993. The project is consistent with Operational Program #1 of the GEF Operational Strategy for climate change, where one of the long-term mitigation measures is to remove the barriers to energy conservation and energy efficiency. A greenhouse gas study for China, jointly prepared and endorsed by the Chinese Government (NEPA and the State Planning Commission), UNDP, and the World Bank, identified the improvement of industrial boilers as a top priority for cost-effective GHG reduction and recommended that the project be implemented immediately. A sizable amount of domestic counterpart funding, approximately twice the size of the GEF grant, is expected to be leveraged. Without the GEF funds, counterpart funds of this magnitude could not be expected to be raised for investment in the boiler industry, or such funds would go to expanding the production of existing low-efficiency models.
PROJECT IMPLEMENTATION
22. The Ministry of Machinery Industry (MMI), which is responsible for technology diffusion, standardization and other national coordinating functions for the industrial boiler industry, will have responsibility for implementing this GEF project. The project enjoys broad national support, with representatives of NEPA, SPC, MMI, the State Economic and Trade Commission (SETC), and the Ministry of Finance (MoF) participating in a project Leading Group. The letter of endorsement from the national GEF focal point is attached as Annex 2. MMI has established a Project Management Office (PMO) for coordinating all project preparation activities, and this unit is likely to reside within the proposed high-efficiency boiler development center during project implementation. Upon completion of the GEF project, the center would continue to operate and be supported entirely through membership and user fees within the boiler industry.
TECHNICAL REVIEW
23. The project was reviewed in December 1994 by an outside technical reviewer from the STAP roster. This first review noted that the project offers significant potential for greenhouse gas reduction and has good prospects. The review stressed, however, that successful marketing and dissemination of the improved boilers would hinge not only upon energy efficiency, but on the other attributes of the boilers as well, such as first cost, pollution controls, ease of operation, and the provision of full service by the boiler manufacturer. These issues were addressed during project preparation with Block C funding support, and have been incorporated into the present project design. A second review was conducted by the same reviewer in January 1996. In the latest review, the technical expert notes that project preparation has been impressive since the first review. The latest review reiterates the importance of "sustainability" issues, including the need for customer service and the importance of using energy efficiency and environmental standards to help promote the improved boiler designs. The reviewer also strongly supports the proposal for establishment of an efficient boiler development center. Sustainability concerns, including cooperation with local officials on enforcing boiler standards, the design and functions of the boiler center, and detailed implementation, will be the focus of work leading up to and during project appraisal. Detailed comments from both reviews are attached as Annex 3.
ISSUES AND ACTIONS
24. The following issues will require particular attention during further project processing: (a) a detailed project implementation plan needs to be worked out, including the role and function of the PMO and the proposed high-efficiency boiler development center; (b) clarification of procurement procedures for international technologies; (c) finalization of counterpart financing arrangements; and, (d) detailed description and agreement on the barrier removal and M&E components.
25. A PDF Block C grant of $746,000 was approved in March 1995 to assist with project preparation activities, including: (a) the international technology assessment; (b) the evaluation of potential international technology licensors; (c) the selection of pre-qualified and winning Chinese enterprise proposals at preappraisal and appraisal; (d) financial and economic evaluation training for domestic enterprises and the PMO, including the calculation of incremental costs; (e) short- and long-term international technical and procurement consultants; and, (f) the remainder of the PMO's project preparation activities through appraisal. Details on the status of PDF implementation are presented in Annex 4.
ENVIRONMENTAL ASPECTS
26. No significant negative environmental effects of the project are expected. In accordance with the World Bank requirements of O.D. 4.01 (Environmental Assessment), this project has been assigned an environmental category of "B". The Chinese side is preparing an Environmental Analysis (EA), which will be reviewed and approved by the World Bank prior to the appraisal mission. The project will provide major environmental benefits in terms of CO2, TSP, and SO2 emission reductions.
PROJECT BENEFITS
27. The direct coal savings over the lifetime of the project (20 years) are estimated to be about 65 million tons of coal equivalent, or 98 million tons of raw coal. This will result in the reduction of 175 million tons of CO2 (all CO2 weights in full molecular weight). Indirect global environmental benefits over the life of the project, through the dissemination of advanced boiler designs and auxiliary equipment to other boiler producers, are conservatively estimated to be in the range of 230-416 mt of coal savings, and a reduction of CO2 of 456-824 mt. The net cost per ton of CO2 reduced for the GEF investment for the project itself would be about US$0.19, while considering the programmatic or indirect CO2 reduction benefits, the GEF cost would be between US$0.03 and US$0.05 per ton of CO2. In addition to CO2 reductions, improved boiler designs will result in significant reductions of local pollution emissions, especially TSP and SO2. Direct project TSP and sulfur dioxide emission reductions are estimated to be 4.4 and 24.1 million tons, respectively, through both energy efficiency improvements and the introduction of emission control technologies.
PROJECT RISKS
28. The project is subject to some of the same technical and commercial risks that it seeks to overcome. Technical risk is being minimized through the commercial demonstration project design, competitive bidding for domestic boiler applicants, close collaboration between Chinese and international engineers, and critical evaluation at each step in the project. Market risk will be reduced by working with environmental and other planning authorities in Chongqing and other municipalities in enforcing efficiency and environmental standards and devising incentive-programs for the adoption of the energy-efficient and less-polluting boilers.
Annex 1: Calculation of Incremental Costs