Document of The World Bank Report No: ICR2597 IMPLEMENTATION COMPLETION AND RESULTS REPORT (IBRD-75310) ON A LOAN IN THE AMOUNT OF US$ 50 MILLION TO THE PEOPLE’S REPUBLIC OF CHINA FOR A SHANDONG POWER PLANT FLUE GAS DESULFURIZATION PROJECT December 21, 2012 China and Mongolia Sustainable Development Unit East Asia and Pacific Region CURRENCY EQUIVALENTS (Exchange Rate Effective November 15, 2012) Currency Unit = RMB/yuan US$ 1.00 = RMB 6.24 FISCAL YEAR July 1 – June 30 ABBREVIATIONS AND ACRONYMS AAOV Annual Average Output Value FGD Flue Gas Desulfurization ADB Asian Development Bank FLI Furnace Limestone Injection APL Adaptable Program Loan FMR Financial Management Report CaO Calcium Oxide FMS Financial Management System CaCO3 Calcium Carbonate FRR Financial Rate of Return CEM Continuous Emission Monitor FY Fiscal Year CFB Circulated Fluidized Bed GDP Gross Domestic Product CNAO China National Audit Office GGH Gas-Gas Heater CNY Chinese Yuan GHG Greenhouse Gas CO Carbon Monoxide GOC Government of China CPS Country Partnership Strategy ICR Implementation Completion CRESP China Renewable Energy and Results Report Scale-up Program IFC International Finance DA Designated Account Corporation DO Development Objective IP Implementation Progress EA Environmental Assessment KPI Key Performance Indicator EIA Environmental Impact LIMB Limestone Injection Modified Assessment Burners EMP Environmental Management M&E Monitoring and Evaluation Plan MOF Ministry of Finance EPA Environmental Protection NDRC National Development and Agency Reform Commission ERR Economic Rate of Return NOx Nitrogen Oxide NPC National People’s Congress SOE Statement of Expenditure NPV Net Present Value SPDRC Shandong Provincial O3 Ozone Development and Reform O&M Operation & Maintenance Commission PDO Project Development Objective SPEPB Shandong Provincial pH Potential of Hydrogen Environmental Protection PIE Project Implementing Entity Bureau PLG Project Leading Group SPFB Shandong Provincial Finance PM Particulate Matter Bureau PMO Project Management Office SPG Shandong Provincial RAP Resettlement Action Plan Government RLG Resettlement Leading Group TA Technical Assistance SBD Standard Bidding Documents TSP Total Suspended Particulate SEPA State Environmental Protection TTL Task Team Leader Administration UNDB United Nations Development SIL Specific Investment Loan Business SO2 Sulfur Dioxide VAT Value Added Tax Vice President: Pamela Cox Country Director: Klaus Rohland Sector Manager: Mark R. Lundell Project Team Leader: Frederic Asseline ICR Team Leader: Frederic Asseline CHINA SHANDONG POWER PLANT FLUE GAS DESULFURIZATION PROJECT CONTENTS Data Sheet A. Basic Information B. Key Dates C. Ratings Summary D. Sector and Theme Codes E. Bank Staff F. Results Framework Analysis G. Ratings of Project Performance in ISRs H. Restructuring I. Disbursement Graph 1. Project Context, Development Objectives and Design ............................................... 1 2. Key Factors Affecting Implementation and Outcomes .............................................. 3 3. Assessment of Outcomes ............................................................................................ 9 4. Assessment of Risk to Development Outcome......................................................... 11 5. Assessment of Bank and Borrower Performance ..................................................... 11 6. Lessons Learned ....................................................................................................... 13 7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners .......... 14 Annex 1. Project Costs and Financing .......................................................................... 15 Annex 2. Outputs by Component ................................................................................. 16 Annex 3. Economic and Financial Analysis ................................................................. 17 Annex 4. Bank Lending and Implementation Support/Supervision Processes ............ 18 Annex 5. Beneficiary Survey Results ........................................................................... 20 Annex 6. Stakeholder Workshop Report and Results................................................... 21 Annex 7. Summary of Borrower's ICR and/or Comments on Draft ICR ..................... 22 Annex 8. Comments of Cofinanciers and Other Partners/Stakeholders ....................... 23 Annex 9. List of Supporting Documents ...................................................................... 24 MAP A. Basic Information Shandong Flue Gas Country: China Project Name: Desulfurization Project ID: P093882 L/C/TF Number(s): IBRD-75310 ICR Date: 11/27/2012 ICR Type: Core ICR PEOPLE'S REPUBLIC Lending Instrument: SIL Borrower: OF CHINA Original Total USD 50.00M Disbursed Amount: USD 5.13M Commitment: Revised Amount: USD 35.04M Environmental Category: b Implementing Agencies: Shandong Provincial Environmental Protection Bureau Co-financiers and Other External Partners: B. Key Dates Revised / Actual Process Date Process Original Date Date(s) Concept Review: 10/27/2005 Effectiveness: 10/15/2008 10/15/2008 Appraisal: 03/30/2007 Restructuring(s): Approval: 05/27/2008 Mid-term Review: 06/01/2012 Closing: 06/30/2012 06/30/2012 C. Ratings Summary C.1 Performance Rating by ICR Outcomes: Unsatisfactory Risk to Development Outcome: Moderate Bank Performance: Unsatisfactory Borrower Performance: Unsatisfactory C.2 Detailed Ratings of Bank and Borrower Performance (by ICR) Bank Ratings Borrower Ratings Moderately Moderately Quality at Entry: Government: Unsatisfactory Unsatisfactory Implementing Quality of Supervision: Unsatisfactory Unsatisfactory Agency/Agencies: Overall Bank Overall Borrower Unsatisfactory Unsatisfactory Performance: Performance: C.3 Quality at Entry and Implementation Performance Indicators Implementation QAG Assessments Indicators Rating Performance (if any) Potential Problem Project Quality at Entry No None at any time (Yes/No): (QEA): Problem Project at any Quality of Yes None time (Yes/No): Supervision (QSA): DO rating before Unsatisfactory Closing/Inactive status: D. Sector and Theme Codes Original Actual Sector Code (as % of total Bank financing) Energy efficiency in Heat and Power 98 98 Sub-national government administration 2 2 Theme Code (as % of total Bank financing) Environmental policies and institutions 33 33 Pollution management and environmental health 67 67 E. Bank Staff Positions At ICR At Approval Vice President: Pamela Cox James W. Adams Country Director: Klaus Rohland David R. Dollar Sector Manager: Mark R. Lundell Ede Jorge Ijjasz-Vasquez Project Team Leader: Frederic Asseline Jianping Zhao ICR Team Leader: Frederic Asseline ICR Primary Author: Frederic Asseline F. Results Framework Analysis Project Development Objectives (from Project Appraisal Document) The development objective of the proposed project is to reduce SO2 emission in the heat and power sector and enhance the capacity of regulatory authorities to monitor and enforce compliance with their SO2 emission reduction program. Revised Project Development Objectives (as approved by original approving authority) The objectives were not revised (a) PDO Indicator(s) Original Target Formally Actual Value Values (from Revised Achieved at Indicator Baseline Value approval Target Completion or documents) Values Target Years Indicator 1 : Total amount of SO2 removed in the heat and power sector Value quantitative or 10,000 tons 900,000 tons 798,000 tons Qualitative) Date achieved 12/31/2005 12/31/2010 12/31/2011 Comments 88.6 % of the target was achieved at the end of year 2011, but none of this SO2 (incl. % removal was associated with project investments. achievement) Indicator 2 : Total amount of SO2 emissions in Shandong Value quantitative or 2.03 million tons 1.6 million tons 1.49 million tons Qualitative) Date achieved 12/31/2005 12/31/2010 12/31/2011 Comments In 2010, the value was 1.54 million tons; 116% of the SO2 reduction target was (incl. % completed during the 11th Five year plan, but none of this SO2 emissions achievement) reduction was associated with project investments. (b) Intermediate Outcome Indicator(s) Original Target Actual Value Formally Values (from Achieved at Indicator Baseline Value Revised approval Completion or Target Values documents) Target Years Component A: Rules and procedures issued on CEM installation, calibration, Indicator 1 : data collection and transmission Value (quantitative Operational Not operational or Qualitative) Date achieved 12/31/2005 12/31/2010 06/30/2012 Comments (incl. % The component was not implemented achievement) Indicator 2 : Component A: Number of staff, managers and operators trained Value (quantitative 0 500 0 or Qualitative) Date achieved 12/31/2005 12/31/2010 06/30/2012 Comments (incl. % achievement) Indicator 3 : Component A: Percentage of installation and proper operation of CEMs in heat and power plants Value (quantitative 10 100 0 or Qualitative) Date achieved 12/31/2005 12/31/2010 06/30/2012 Comments (incl. % achievement) Indicator 4 : Component A: Online monitoring system Value (quantitative Operational Not operational or Qualitative) Date achieved 12/31/2005 12/31/2010 06/30/2012 Comments (incl. % achievement) Indicator 5 : Component A: SO2 control policy and regulation prepared Value (quantitative Operational Not operational or Qualitative) Date achieved 12/31/2005 12/31/2010 06/30/2012 Comments (incl. % achievement) Indicator 6 : Component B: Installation fo FGDs and CEMs at the four sites on schedule Value Not operational at (quantitative Operational any of the four sites or Qualitative) Date achieved 12/31/2005 12/31/2010 06/30/2012 Comments (incl. % achievement) Indicator 7 : Component B: Achievement of the target SO2 removal efficiency Value (quantitative 0 90-95% 0 or Qualitative) Date achieved 12/31/2005 12/31/2010 06/30/2012 Comments (incl. % achievement) Indicator 8 : Component B: Total tonnages of SO2 removed annually at the five sites Value (quantitative 0 58,645 0 or Qualitative) Date achieved 12/31/2005 12/31/2010 06/30/2012 Comments (incl. % achievement) Indicator 9 : Component B: Achievement of the target emission rate (400 mg/Nm3) Value (quantitative All None or Qualitative) Date achieved 12/31/2005 12/31/2010 06/30/2012 Comments (incl. % achievement) G. Ratings of Project Performance in ISRs Actual Date ISR No. DO IP Disbursements Archived (USD millions) Moderately 1 06/26/2009 Moderately Satisfactory 5.00 Unsatisfactory Moderately Moderately 2 06/28/2010 15.93 Unsatisfactory Unsatisfactory 3 06/28/2011 Unsatisfactory Unsatisfactory 15.93 4 04/10/2012 Unsatisfactory Unsatisfactory 5.00 Note: This disbursement of US$ 5 million is the balance in the DA being returned to the World Bank (unused as no eligible project investments took place) and the front end fee. H. Restructuring (if any) Not Applicable. I. Disbursement Profile 1. Project Context, Development Objectives and Design 1.1 Context at Appraisal 1. At the time of appraisal in year 2007 China’s GDP had been growing at a sustained average annual rate of 9 percent since 1980, a growth sustained by a tripling of primary commercial energy consumption, from 600 million tons of coal equivalent (Mtce) in 1980 to 2,200 Mtce in 2005. This rise in energy demand was met by a sharp increase in domestic coal consumption, of which more than 50 percent was used for electricity generation in 2005. Projections at the time of appraisal showed that electricity generation capacity would increase from 508 GW in 2005 to more than 1,100 GW by 2020, of which more than 700 GW would be coal-based. 2. The heavy reliance on coal and the rapid expansion of the power generation system led to severe air pollution, caused primarily by the sulfur dioxide (SO2) released by coal combustion. The State Environmental Protection Administration (SEPA) estimated that in 2005, a total of 25.5 million tons of SO2 was released in China of which 90 percent was contributed by coal combustion. SO2 pollution caused acid rain in more than half of China’s 696 cities, and it caused local and regional pollution with PM2.5 particles as the main factor of increased levels of respiratory diseases and related premature deaths. 3. In 2004, Shandong province consumed 159 million tons of coal, ranking second among all the Chinese provinces in coal consumption and producing the highest amount of SO2 emissions in China. Coal accounted for 82 percent of primary energy consumption in the province, compared to a national average of about 67 percent at the time. In 2005, SO2 emissions in Shandong Province amounted to 2.03 million tons, of which 1.17 million tons, or 52.4 percent, were contributed by the power and heat industry. 4. The 11th Five-Year Plan approved by the National People’s Congress (NPC) had set a target to reduce the country’s SO2 emission by 10 percent from the 2005 level by the year 2010. Accordingly, SEPA signed agreements with the seven largest SO2- emitting provinces (including Shandong) and the six major power-generating companies with specific SO2 emission control targets. The Shandong Provincial Government (SPG) embraced the Central Government’s SO2 control policies and targets by developing its own even more stringent SO2 emission control targets and compliance plan. The SPG’s plan called for an overall 20 percent SO2 emission reduction by 2010 on the 2005 emission level. To achieve these targets, the SPG needed to develop detailed implementation rules and plans, mobilize adequate financing, upgrade environmental monitoring facilities and information systems, strengthen environmental governance and institutional capacity to ensure compliance, and create emission certificates and emission rights trading schemes. 5. Consistent with the power sector reform program in China, the five large national power generation companies undertook SO2 control projects with their own resources or with commercial financing. However, a large segment of the power and heat sector had 1 boiler units with a capacity of less than 1,100 t/h range. These units were owned by provincial and local governments, and had neither access to commercial financing nor adequate own resources to finance SO2 control projects. The Bank and other multilateral financial institutions were called to support this niche segment of the power sector. 6. One important theme of the Country Partnership Strategy (CPS) discussed by the Board of Executive Directors on May 23, 2006, was to manage resource scarcity and environmental challenges, especially through the mitigation of air pollution. The project was to directly contribute to achieving these objectives through financing SO2 control facilities and strengthening effectiveness of environmental institutions. 1.2 Original Project Development Objectives (PDO) and Key Indicators 7. The development objective of the proposed project was to reduce SO2 emission in the heat and power sector and enhance the capacity of regulatory authorities to monitor and enforce compliance with their SO2 emission reduction program. 8. Measures of project output during project implementation included physical progress in procurement, construction, and commissioning of the Flue Gas Desulfurization (FGD) facilities, availability and SO2 removal efficiency of the FGD facilities, and progress in the implementation of the Technical Assistance (TA) Component, including Continuous 9. Emission Monitor (CEM) installation rate and the level of SO2 emission fee collection. 10. Measures of project outcome were the reduction of SO2 emissions in Shandong Province and the direct contribution of the project to these reductions. 1.3 Revised PDO (as approved by original approving authority) and Key Indicators, and reasons/justification 11. The objectives and key indicators were not revised. 1.4 Main Beneficiaries 12. The main beneficiaries identified in the PAD were: 1) the environmental institutions in Shandong Province, notably the Shandong Provincial Environmental Protection Bureau and the municipal level environmental protection bureaus in the province; 2) operators of the FGD systems at the sub-projects included in the project scope; and 3) the Shandong Provincial Government. The attainment of the PDO would benefit the general population of Shandong Province. 1.5 Original Components 13. Technical Assistance Component: To strengthen the technical and institutional capacity related to SO2 emission control and reduction in Shandong. It includes: (i) 2 capacity building and enhancement in emission monitoring and regulation enforcement, including upgrading of online monitoring equipment and information systems; (ii) technical and managerial training; and (iii) development of related regulations, procedures, and policies. 14. Investment Component: To finance the installation of FGD facilities at four coal- fired heat and power plants. These plants include existing coal-fired cogeneration units and cogeneration units that were under construction or planned for construction. All plants had selected to install limestone-gypsum wet FGD technology. 1.6 Revised Components 15. The original components were not revised. 1.7 Other significant changes 16. Three of four subprojects dropped out of the investment component of the project prior to loan effectiveness generally because alternative sources of financing were available. The fourth was cancelled due to discovery of fraudulent practices. Loan funds were reimbursed and subsequently the corresponding amount of the IBRD loan was cancelled in June 2011. There were no other significant changes in the project design, scope, scale, implementation arrangements, schedule and funding allocations. 17. The relative focus of project implementation changed after the three appraised subprojects dropped out because the Bank team spent most of its time trying to regenerate a pipeline of appraised subprojects. For reasons discussed below, this effort not only proved to be wholly unsuccessful but also diminished the focus on the project’s Technical Assistance component and on the tracking of the PDO indicators (for which information was obtained only during the ICR elaboration period). Had the TA component gone ahead, capacity to monitor the SO2 reduction program could have been improved, and the project would have been able to partially achieve the development objective. This did not occur given the excessive focus on the Investment component, which was far less relevant given superior parallel efforts to achieve FGD investments outside of the project. 2. Key Factors Affecting Implementation and Outcomes 2.1 Project Preparation, Design and Quality at Entry 18. The PDO and the project design were aligned with the Bank’s energy sector strategy in China as articulated in the CPS discussed by the Board of Executive Directors on May 23, 2006. One important theme of this CPS was to manage resources scarcity and environmental challenges, especially through the mitigation of air pollution. At the component level, technical experts were brought in to assist in review of technical options, demonstrating a concerted effort to advance international best practices into project design, and a thorough economic analysis was undertaken. 3 19. The project correctly identified three criteria for the successful implementation of an SO2 emission reduction program: (a) existence of enforceable environmental regulations and standards, (b) adequate institutional capacity to implement and enforce laws and regulations; and (c) adequate policies and schemes to encourage and facilitate investment in SO2 control facilities and penalize noncompliance. 20. The Technical Assistance (TA) Component was meant to address these three criteria. The component was designed to be financed from the proceeds of the loan and implemented by the Shandong Provincial Environmental Protection Bureau (SPEPB). Shandong Province declared its commitment to support project management under the Project Agreement; however, no formal agreement between the Shandong Provincial Finance Bureau (SPFB) and the SPEPB was requested at entry to ensure funds would be made available to the SPEPB. While the PMO was placed in the SPEPB which was the primary beneficiary of the technical assistance and responsible for meeting the SO2 target, SPEPB paid inadequate attention to the resources and capacity of the SPEPB PMO to implement its responsibilities for the TA component. 21. The project correctly identified adequate and early procurement planning, along with realistic cost estimates as crucial to the rapid and effective implementation of the investment component of the project, two key lessons learned from previous energy projects. Four investment sub-projects were designed and early procurement planning put in place with rational packaging. 22. However, the design of the project quickly proved to be insufficiently robust due mainly to (a) a weak SPEPB project management office which did not manage to establish sufficiently close communications with subproject entities or undertake appropriate supervision of subproject activities; and (b) the apparent lack of awareness by project management and the Bank of the deliberations by the counterparts on the preferred type of SO2 removal technology. Additionally, the availability of alternative sources of financing in the province was not as scarce as envisioned at preparation, and this financing was more attractive than Bank terms because it was much easier to put in place. The target set of enterprises to be served by the project in the province (the segment of the power and heat sector with boiler units with a capacity of less than 1,100 t/h range) was not as large as anticipated at appraisal and shrinking very rapidly due to such enterprises moving quickly to comply with the stringent environmental regulatory requirements owing to a delay in project approval (6 months from decision meeting to appraisal completion, 9 months from appraisal completion to negotiations, and another 6 months to effectiveness). 23. The delays were caused mainly by delays in domestic approvals for four new heat and power plants for which the project was proposed to finance the associated FGD facilities and the SPFB’s interest in maintaining the $100 million World Bank loan allocation for the project, while subprojects to be appraised following the decision meeting totaled only about $73 million. Additional subprojects could not be successfully appraised despite an extended appraisal process. In the end, four subprojects remained at negotiations, of which three dropped out before effectiveness (reasons provided below under implementation). In parallel, by the end of 2009, one year after effectiveness, the 4 province had already exceeded its SO2 emissions target with cumulative reductions achieved at 103%. 1 This trend quickly accelerated with the province achieving a reported 116% of its target by 2010. 24. The risks to project development objective were correctly identified and assessed. Given the lack of implementation in the project, a closer look at the risks to project components is warranted. The risks assessed at entry to component results were: (a) low availability of FGD equipment because of technical defects and lack of technical skills of plant operators (Negligible rating); (b) low utilization rate of FGD facilities because of plant owner’s tendency to reduce operation costs (Modest rating); (c) Limited effectiveness of the TA component (High rating); (d) Poor attention to and compliance with safeguards requirements (Negligible rating). All of the above risks were correctly identified and rated. However, the mitigation measures (SPEPB and others have shown adequate capacity and eagerness to further enhance their capabilities. The scope of the TA is designed to fit to the specific needs of receiving agencies.) were clearly inadequate. Moreover, the risk that alternative sources of financing would replace Bank loan funds was not identified and assessed, even though lack of such financing was one of the main assumptions in the project concept. 2.2 Implementation 25. For a number of reasons noted below, neither project component was implemented even partially. Under these circumstances, normally, an Implementation Completion Memorandum would be prepared, but since over 10 percent of the loan funds were disbursed (later to be refunded in full, excluding the front-end fee, as explained below) an ICR has been deemed the necessary report. The project was closed on June 30, 2012, without having disbursed proceeds for any eligible expenditure from the loan. The reasons for failure to make eligible use of loan funds are different for each component (as noted below). The fast evolving SO2 control achievements of Shandong Province made circumstances very difficult for project restructuring. 26. The Technical Assistance component was not implemented. The Project Management Office (PMO) did not submit a work plan to the Bank for the development of the TA component, despite several requests from the Bank team reinforced by management letters. It was reported by PMO staff that the funds needed to implement the TA component were not made available by Shandong Finance Bureau due to internal, inter-agency processing requirements (a recipients agreement to repay used funds), which fundamentally impeded the use of loan funds for TA. The Department which was the beneficiary for this technical assistance did not appear to play an active role in resolving the issues between the two agencies. 1 Source: the Environmental Bulletin of the Shandong Environment Protection Bureau website, published by the pollution control office of Shandong EPB (http://www.sdein.gov.cn/). 5 27. The investment component was also not implemented. Three of the four sub- projects identified at appraisal were dropped before project effectiveness (Laiwu thermal power plant, Huangtai thermal power plant, and Yantai thermal power plant) because alternative sources of financing were identified. In the case of Huangtai and Yantai, the project sponsor decided to increase the size of the CHPs (from 2x300 MW to 2x600 MW), requiring a new cycle of local and national re-approvals, stopped taking any action on the FGD subcomponents, and indicating a strong desire to drop from the project. In the third subproject, the subproject sponsor (who owns the Huangtai subproject and holds the largest equity shares in the Yantai sub-project and Laiwu sub-project) did not actively pursue counter-guarantee arrangements with SPFB and also asked to exit the project. The overall explanation given by the three thermal power plants for pulling out was that procedures for accessing Bank financing were complex and took too long to materialize, in a context where local funding could be accessed much faster. 28. Of the four original investment projects identified, only the Lubei Thermal Power Plant Co. Ltd received funding from the Bank loan to install an FGD system. A supply contract was signed on December 2, 2008, and approved for IBRD financing (US$ 14,962,500). However, the Bank team discovered fraudulent practices, as defined under paragraph 1.14(a)(ii) of the Bank’s May 2004 Procurement Guidelines, on the contract signed on December 2, 2008, for the Lubei sub-project. As a result, funding for the Lubei sub-project was reimbursed to the Bank in June 2011 and subsequently the corresponding Bank loan amount was cancelled. The Bank did receive a request to reallocate funds to the Lubei Thermal Power Plant subproject, which was not accepted. The Bank did not receive any further request from the Ministry of Finance to restructure the project. Consequently, the project was closed on June 30, 2012, its original closing date. No disbursements from the remaining part of the loan were made. 29. It should be noted that during the course of the project, the Shandong Finance Bureau and SPEPB had presented several new subproject proposals in view of a potential restructuring. After initial screening, only a subset of these proposals was deemed consistent with the PDO. The Bank team worked extensively to complete the appraisal process with the potential beneficiary enterprises but the subprojects eventually were not able to meet Bank appraisal requirements, owing to the fact that (1) the cost estimates and financing requirements kept changing even at late stages of appraisal; (2) the proposed new subprojects changed a number of times with some dropping out to seek local financing and then replaced by SPFB with new proposals; (3) the local approvals needed by appraisal could not be obtained in a timely manner. As noted above, the fast evolving achievements in SO2 control in Shandong Province placed pressure on potential subproject sponsors to undertake control measures, which they could achieve more quickly following industry practices than through use of the World Bank’s loan, which has additional due diligence and processing requirements (both domestic procedures on the use of foreign capital and Bank procedures). Proactive guidance by the Bank on when restructuring no longer appears to be a realistic option (in such cases when the Bank team and its clients are unable to deliver over a long period of time) is a key lesson discussed below. 6 2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization M&E Design 30. The M&E framework was designed on a set of indicators corresponding to the objective of the PDO (outcome indicator) and to the project’s physical progress and provincial SO2 emissions monitoring as indicated in the Data Sheet. M&E Implementation 31. Monitoring of the Component A (technical assistance) was not conducted because the component was not implemented. Monitoring of component B was conducted for two years from early 2009 to 2011 for the Lubei sub-project only because the three other sub-projects described in the PAD were dropped in 2008. The Lubei sub-project was cancelled because of fraud and the Bank funding returned. From an operational and environmental monitoring perspective, the monitoring parameters at Lubei, as documented in mission aide memoires and ISRs for these two years, show that the FGD operation was efficient and meeting both operational and environmental targets. 32. The Provincial Government conducted monitoring of progress toward meeting its 11th Five Year Plan SO2 control targets. In year 2007, the total amount of SO2 emissions in Shandong was 1,822, 200 tons, and this represented a reduction of 7.12% from 2006 levels. In year 2008, when the project was approved and became effective, SO2 emissions were further reduced by 7.15% relative to year 2007, with a total emissions amount that year of 1,691,900 tons. By the end of year 2009, one year after effectiveness, the Province had further reduced its SO2 emissions by 6.01% relative to 2008, with cumulative emission reductions accounting for 103% of the SO2 reduction target set for Shandong province at national level for the entire 11th Five Year Plan. In 2010, SO2 emissions were further reduced by 3.3 ％ , contributing to a cumulative reduction rate of 23.22% for the province since year 2007. By the end of 2010, Shandong had reached 116% of the SO2 emission reduction target that had been set for the province in the 11th Five Year Plan. Indicators (end of year) 2006 2007 2008 2009 2010 2011 PDO Indicator Actual Actual Actual Actual Actual Actual Value Value Value Value Value Value Total amount of SO2 removed 102.6 95.92 86.26 77.27 75.9 79.8 in the heat and power sectors (tons) Baseline 2005: 10,000 tons Total amount of SO2 196.2 182.22 169.19 159.03 153.78 149.08 emissions in Shandong reduced (tons) Baseline 2005: 2.03million tons Source: the Environmental Bulletin of the Shandong Environment Protection Bureau website, published by the pollution control office of Shandong EPB (http://www.sdein.gov.cn/). Total installed capacity 17817 MW 31625 57467 60786 62486 68048 MW MW MW MW MW Source: Heat and Power annual reports of the Shandong Economic and Information Committee 7 M&E Utilization 33. The M&E framework was not utilized since project components were not implemented. The province easily met outcome indicator targets, without contribution from the project. 2.4 Safeguard and Fiduciary Compliance 34. The project was a Category B. A satisfactory Environmental Impact Assessment (EIA) and Environmental Management Plan (EMP) were prepared for the Lubei sub- project. This sub-project was subsequently cancelled due to the discovery of fraudulent practices. 35. The FGD system installed at Lubei used a technology different from that described in the PAD. The change was from a Calcium Based Nonregenerable FGD System (as described in the PAD) to a Magnesium Based Regenerable System. The change was made so that Lubei could make better use of the spent sorbent as an input to its fertilizer production process. The lime-limestone process, described in the PAD, produces a spent sorbent that is basically gypsum, to be used as a building material or simply discarded, while the latter process produces magnesium sulfite which can be treated to release concentrated sulfur dioxide used as a feedstock in sulfuric acid manufacturing. The treatment regenerates magnesium oxide which is recycled back to the FGD unit. It was Lubei’s intention to utilize the sulfuric acid to make phosphoric acid by digesting calcium phosphate ore and utilizing the phosphoric acid in the production of fertilizers. The technology change request to the Bank was made to and approved by the Bank during project implementation. A revision to the Environmental Management Plan (EMP) to reflect this change should have been made at the time of approval. Still, the update of the EMP was eventually completed. Discussions with both Provincial and local EPB officials indicated that all Chinese environmental assessment procedures were properly followed in allowing the technology change. 2.5 Post-completion Operation/Next Phase 36. As noted in the Monitoring and Evaluation section above, Shandong had achieved, and even surpassed, its 11th Five Year Plan SO2 emission reduction targets already by 2009. Environmental regulations to reduce SO2 emissions were reported to be successfully introduced and uniformly implemented throughout the province. As early as 2008, all large existing power producers had retrofitted their plants with FGD systems and after 2008, all new power plants large or small were required to be commissioned with FGD systems. After 2008 new power plants without FGD systems could not receive authorization from provincial EPB and provincial DRC to operate. This policy continues today. 37. Only a handful of smaller, older plants remained as candidates for retrofits after 2008. Most of these plants did install FGD systems during the 11th Five Year Plan, and they did so using their own financing or local financing sources. 8 3. Assessment of Outcomes 3.1 Relevance of Objectives, Design and Implementation Rating: Moderately Unsatisfactory 38. The project’s objectives remain largely consistent with China’s focus on sustainable economic growth and reducing environmental impacts of energy use. China’s Energy Policy White Paper (2012) clearly notes under the heading “Promoting Clean Development of Fossil Energy� that new built coal fired thermal power generation must install dust removal, desulfurization and nitrous oxide emission control facilities and existing plants are encouraged to accelerate the deployment of emission controls. 39. The new CPS (FY2013-2016) acknowledges the great strides undertaken by China in air pollution, the costs of air pollution, the cost of illnesses from pollution has climbed as the population ages and the urban populations grows. The CPS has as one of its pillars the demonstration of pollution management measures. While not focusing exclusively on SO2 controls, it does include supporting efforts to reduce urban air pollution, working at both the national level (providing TA related to standards, monitoring, and regional strategies) and the municipal level (supporting detailed action plans and investments designed to reduce pollution from the worst sources). Regarding the energy sector, the CPS shows the Bank has also adapted its support plan, focusing on assisting China’s efforts to support a sustainable energy path through scale up of renewable and energy efficiency, finding low carbon energy solutions in cities, promoting innovative solutions to development of clean energy policies. 40. The project objectives broadly correspond to the Government’s environmental objectives and the project’s design and objectives corresponded closely with the Shandong Provincial Government’s SO2 control plan. However, it should be noted that the relevance of the project diminished during the extended two year project preparation period and during the project implementation period. At appraisal, it was not projected that SO2 targets set out during the 11th FYP in 2006 were going to be fully achieved by 2009. The SPG reported to have attained 103 % of the target by the end of 2009, only one year after project effectiveness. As described in section 2.3 above, by 2010 the province had reached 116% of its 11th Five Year Plan SO2 emission reduction target. The EPB project management office staff reported 95% percent of the plants in Shandong being equipped with FGD systems by late 2009. Had the project been more quickly approved and deployed it would have been more likely to contribute to SPG’s efforts. In the end, the two project components were not implemented as designed and produced no project outcomes. 41. In summary, while the objectives of the project were set out in a satisfactory manner and remain consistent with broad environmental objectives today, the project’s design and implementation is less relevant given the policies and procedures in place for SO2 controls. The delayed initial implementation undermined the potential contribution the project may have had to current policies and programs supporting air pollution control. As a result of the above the relevance of project objectives, design and implementation was moderately unsatisfactory. 9 3.2 Achievement of Project Development Objectives Rating: Unsatisfactory 42. None of the two project components were implemented, and therefore the project did not finance any investments that could contribute to achieving its development objective. 43. However, as noted above, development outcomes were reached by Shandong province without the intervention of the project. 3.3 Efficiency Rating: Unsatisfactory 44. Efficiency as defined as the rate of return or cost effectiveness of project investments is not applicable under the project. Three subprojects were dropped prior to effectiveness and one subproject was cancelled due to fraudulent practices. The technical assistance project was not implemented. As there are no project inputs, there is no data on which to make a determination of project efficiency. A rating of unsatisfactory is assigned based on the fact that, in addition to the client’s time and resources, the Bank spent $424,000 (preparation and supervision) without any discernible contribution of project activities to the development objective as noted above. 3.4 Justification of Overall Outcome Rating Rating: Unsatisfactory 45. Based on the above ratings that reflect the fact that neither of the two project components was implemented, the project outcome rating is unsatisfactory. 3.5 Overarching Themes, Other Outcomes and Impacts 46. Poverty Impacts, Gender Aspects, and Social Development. Not applicable. 47. Institutional Change/Strengthening. The project intended to strengthen SPEB’s capacity in SO2 control but could not contribute to this objective because the technical assistance component was not implemented. 48. Other Unintended Outcomes and Impacts (positive or negative). The Bank maintains an ongoing portfolio in Shandong province, including in the energy sector. The project’s experience has alerted teams to work with Shandong Finance Bureau more closely on adequate project management financing and to conduct more vigilant financial management supervision. 3.6 Summary of Findings of Beneficiary Survey and/or Stakeholder Workshops 49. Not applicable. 10 4. Assessment of Risk to Development Outcome Rating: Moderate 50. Given the previous ratings of the project, a conclusion could be drawn that the risk to development outcomes is high. However, the reported progress of the SPG in SO2 control and supporting regulations suggests that a moderate risk to development outcomes is a more appropriate assessment. There is insufficient evidence on the quality of implementation to justify a lower rating. While the SPG appears to have found alternative financing sources to build capacities the project aimed to do, there was a missed opportunity to use project funds to bring in international experience and best practices in least cost environmental planning and implementation, and developing local institutional capacity required for monitoring and enforcement of environmental regulation. 5. Assessment of Bank and Borrower Performance 5.1 Bank Performance (a) Bank Performance in Ensuring Quality at Entry Rating: Moderately Unsatisfactory 51. Given the ratings discussed in Section 3.1 above on Relevance of Objectives, Design and Implementation, the Bank’s performance at quality at entry is assessed as moderately unsatisfactory. Technical experts were brought in to assist in review of technical options, demonstrating a concerted effort to advance international best practices into project design, and a thorough economic analysis was undertaken. However, inadequate attention was paid to assessing the implementing arrangements and SO2 control technology choices contemplated by the subproject entities. The wet limestone gypsum FGD process described in the appraisal document is not the FGD technology that was selected by the Lubei sub-project, which opted for a Magnesium oxide FGD system. 52. As noted above, no formal agreement between the Shandong Provincial Finance Bureau (SPFB) and the SPEPB was sought to ensure funds would be made available to the SPEPB both for TA and project management. Provincial regulatory requirements placed significant time pressure on power generators to equip their plants with FGD systems and only one year after project effectiveness, close to 95% of power plants in Shandong province were equipped with FGD systems. (b) Quality of Supervision Rating: Unsatisfactory 53. The overall performance of Bank supervision was unsatisfactory. The financial management supervision was highly satisfactory and the team handled the discovery of fraudulent practices effectively. The Bank team also worked to identify a short list of alternative subprojects that were proposed by the Shandong Provincial Finance Bureau throughout the project period. However, the lack of adequate information regarding these potential new subprojects increased the input requirement of supervision and distracted 11 the team from placing adequate focus on tracking the Province’s wider efforts on reducing SO2 emissions. Greater management guidance and support to the team could have helped to establish better balance in this regard, perhaps with an early cancellation or raising issues with Government counterparts to accelerate new subproject preparation. In addition the Bank team should have requested a view of the Project Leading Group, the high level steering committee of the project, when unsatisfactory implementation persisted. 54. In summary the Bank team was so focused on assisting the Province with preparing a restructuring package, which persistently changed, and later on the due diligence that was needed upon the discovery of fraudulent practices that it could not focus on tracking the SO2 emission reduction program undertaken by the Province. This imbalance in focus of project supervision leads this ICR to deem the Quality of Supervision as unsatisfactory. (c) Justification of Rating for Overall Bank Performance Rating: Unsatisfactory 55. Bank performance is rated unsatisfactory, based on the ratings for quality at entry and supervision. 5.2 Borrower Performance (a) Government Performance Rating: Moderately Unsatisfactory 56. Overall, government performance is rated moderately unsatisfactory. Government was committed to the project during preparation and was proactive in attempting to reprogram the use of loan funds. However, project outcomes may have been achieved with a well-supported PMO, capable of adjusting the TA component, communicating closely with identified subproject sponsors to ensure they understood requirements and timelines, and facilitating timely and adequate preparation of alternative subprojects. The TA component could not be implemented due to the inability of SPFB and SPEPB to complete internal processing requirements. The passivity of the SPEPB in resolving the matter may be an indication of its waning interest in the TA as a result of its good progress in achieving its SO2 targets. 57. Also, failure to identify the fraud that occurred in the Lubei sub-project suggests that inadequate financial management control mechanisms were put in place for the project. The financial management control mechanisms did not (i) maintain proper financial management systems and enhance the controls over transactions including compliance with legal agreements and eligibility criteria, and (ii) enhance the controls over transactions financed by the Bank including proper reconciliation of data, compliance with legal provisions and eligibility, before processing such transactions. (b) Implementing Agency or Agencies Performance Rating: Unsatisfactory 12 58. The implementing agency performance is rated unsatisfactory. The PMO in the Shandong Provincial Environmental Protection Bureau (SPEPB) did not to produce a satisfactory work plan for the TA component. Despite efforts to identify new sub-projects to replace the three original sub-projects that were dropped, the PMO lacked capacity to provide the Bank team with complete appraisal packages for newly proposed subprojects. 59. Moreover, the SPEPB did not maintain sufficiently close contact with the project implementation entities to monitor their deliberations and alert the Bank on the major changes that quickly occurred during project implementation. The project implementing entity of the Lubei investment subcomponent also failed to identify fraudulent practices. 60. Still, the PMO was diligent in assisting the Bank team during the fact finding mission during the due diligence conducted upon discovery of fraudulent practices. (c) Justification of Rating for Overall Borrower Performance Rating: Unsatisfactory 61. Overall Borrower performance is rated unsatisfactory based on the ratings of the performance of the government and the implementing agencies. 6. Lessons Learned 62. A project supporting mandatory targets should carefully time project support with the targets’ timeline. The PDO was timely and relevant at the time of identification and preparation, but the ability of the project to make an impact was continuously reduced as developments in the province quickly outpaced the preparation of the project. The expectations and timelines of subproject sponsors outpaced and mismatched with the project’s preparation timeline. 63. Early communication to the final borrowers of the Bank’s project cycle and timing of availability of funding is needed, especially when working with corporations. The Bank requirements and procedures, and the internal requirements for the use of foreign capital, appear to have been misunderstood by the subproject sponsors at the time of appraisal. This may have been a key underlying reason for the dropout of the three subprojects that were in the original design. The target set of enterprises to be potentially assisted in making FGD retrofits in the province was a shrinking one, with most of the large power producers equipped. With all of the new operators (large or small) moving to equip themselves with FGC technology as mandated by regulations, the project could target only retrofitting of small plants linked to industrial electricity production. Given the lack of sufficient knowledge of Bank subproject appraisal procedures and requirements, the uncertainty of qualifying quickly for access to project loan funds drove these enterprises to alternative sources of financing. 64. Advance procurement of technical assistance, on a retroactively financed basis, and greater attention to final recipients of the technical assistance could mitigate risks of poor loan-financed TA execution. Even well-justified and necessary loan-financed 13 technical assistance carries high borrower performance risk because few borrowers appreciate its value added in advance of implementation. Borrowers prefer grant financed TA, even in middle income countries. Finance bureaus do not wish to carry the loan repayment responsibility on their budgets especially for TA implemented in other agencies. The TA component failed because the SPFB and SPEPB could not agree on these internal arrangements during implementation to overcome aversion to use of non- grant resources for TA activities. A willingness to undertake the TA component early in project implementation is a sign of commitment to the use of loan financed TA, and that internal arrangements are settled. The Bank team could have had a more balanced focus on resolving the lack of progress in the TA component, rather than focusing only on the issues between the PMO and SPFB. An engagement with the leadership of the relevant departments in the SPEPB, which were to be the final beneficiaries of the TA, could have helped to solve the issues. 65. Strong project management units are needed to support finance bureaus in supervising multiple subprojects. This includes implementation arrangements with clear and transparent financial management systems, complemented with Bank team fiduciary supervision plans tailored to the assessed risk. 66. The Bank needs to be more proactive and clearer on initiating project restructuring. Client orientation and responsiveness are hallmarks of good project management. Few clients like to cancel IBRD loan funds and Bank teams work very hard to accommodate these requirements. In addition, central governments wish to avoid multiple restructurings, which in turn creates barriers to efficient, partial adjustments that would help achieve the PDO even without full use of loan proceeds within the original implementation period. Clear guidance for task teams on good practices in restructuring would help task teams be forthcoming and able to attain earlier resolution of flaws in project design despite client reluctance towards early restructuring. 7. Comments on Issues Raised by Borrower/Implementing Agencies/Partners 67. Borrower/implementing agencies. Comments have not been received. 68. Cofinanciers. Not applicable. 69. Other partners and stakeholders. Not applicable. 14 Annex 1. Project Costs and Financing (a) Project Cost by Component (in USD Million equivalent) Actual/Latest Appraisal Estimate Percentage of Components Estimate (USD (USD millions) Appraisal millions) Investment 74.955 0.00 0.00 Technical Assistance 2.28 0.00 0.00 Total Baseline Cost 77.235 0.00 0.00 Contingencies 4.36 0.00 0.00 Interest during construction 4.42 0.00 0.00 Front-end fee 0.125 0.00 0.00 Total Financing Required 86.14 0.00 0.00 (b) Financing Appraisal Actual/Latest Type of Estimate Estimate Percentage of Source of Funds Cofinancing (USD (USD Appraisal millions) millions) Borrower 17.23 0.00 0.00 International Bank for Reconstruction 0.00 50.00 0.00 and Development Local Sources of Borrowing Country 18.91 0.00 0.00 Sub-borrower(s) 0.00 0.00 0.00 86.14 0.00 0.00 15 Annex 2. Outputs by Component There were no outputs. 16 Annex 3. Economic and Financial Analysis Not applicable as none of the project investments were made. 17 Annex 4. Bank Lending and Implementation Support/Supervision Processes (a) Task Team members Responsibility/ Names Title Unit Specialty Lending Zhao Jianping Senior Energy Specialist EASCS Task Team Leader Peter Meier Economist EASTE Economic Analysis Dawei Yang Procurement Specialist EAPCO Procurement Efstratios Tacvoulareas Senior Operations Officer CEUSB Operations Support Senior Procurement Specialist (Co- Yuling Zhou EASTE Procurement TTL) Jian Xie Senior Environmental Specialist EASRE Environment Richard Spencer Senior Energy Specialist EASVS Energy Bernard Baratz Consultant EASCS Mei Wang Senior Counsel LEGAM legal Supervision/ICR Frederic Asseline Senior Energy Specialist EASCS Task Team Leader Gailius Draugelis Lead Energy Specialist EASCS Task Team Leader Bernard Baratz Consultant EASCS Cristina Hernandez Program Assistant EASWE Yi Dong Sr Financial Management Specia EASFM Haixia Li Sr Financial Management Specia EASFM Jingrong He Procurement Specialist EASPM Shawna Fei Li Junior Professional Associate EASIN Guojun Ma Consultant EASCS Peter Meier Consultant EASWE Efstratios Tavoulareas Senior Operations Officer CEUSB Helmut Erich Vierrath Consultant EASIN Mei Wang Senior Counsel LEGAM Lynn Wang Consultant EASFM Dawei Yang Consultant EASTS Youxuan Zhou Consultant Chunxiang Zhang Operations Analyst GFDRR (b) Staff Time and Cost Staff Time and Cost (Bank Budget Only) Stage of Project Cycle USD Thousands (including No. of staff weeks travel and consultant costs) Lending FY06 182.04 FY07 107.99 FY08 29.68 Total: 319.71 Supervision/ICR 18 FY09 36.82 FY10 23.88 FY11 38.71 FY12 6.83 Total: 106.24 19 Annex 5. Beneficiary Survey Results Not applicable 20 Annex 6. Stakeholder Workshop Report and Results Not applicable 21 Annex 7. Summary of Borrower's ICR and/or Comments on Draft ICR Borrower’s inputs were not received. 22 Annex 8. Comments of Cofinanciers and Other Partners/Stakeholders Not applicable. 23 Annex 9. List of Supporting Documents 1. Project Appraisal document 2. Project legal documents including project agreement and loan agreement 3. Project file containing records of project preparation and appraisal 4. Supervision aide-memoires, management letters, and Implementation Status and Results reports 5. Project Feasibility Studies 6. Environmental Bulletin of the Shandong Environment Protection Bureau website, published by the pollution control office of Shandong EPB (http://www.sdein.gov.cn) 24 Annex 10. Map Map No.: 38067-CN 25