|Project Rationale and Linkage to Country/Regional Strategy
The project has a very good fit and direct relevance with the ongoing and targeted energy intensity improvements in the PRC for the next 10 years to meet the 40% 45% carbon intensity improvement by 2020 compared with 2005. The project follows and complements a previous successful Asian Development Bank (ADB) loan in a similar energy-intensive Guangdong province. Shandong is the second largest in terms of industrial outputs among all provinces in the PRC. Accordingly, the industry sector is the main energy consumer in Shandong consuming more than three-quarters of total energy in 2009. Moreover, the energy supply in Shandong is heavily dependent on high carbon fossil fuels - coal (77%) and oil (21.2%) - causing large emissions. The province's total energy consumption in 2009 was 324 million tons of standard coal equivalent (tsce) 10% of the national total. Shandong's economy, has grown consistently at a rapid rate, expanding at an average rate of 12.49% per annum between (1995 2009). This economic growth momentum in Shandong is expected to continue in the foreseeable future putting even greater emphasis on accelerating investments in energy efficiency.
In the first 4 years of the Eleventh Five-Year Plan, 2006 2010, Shandong Province's energy consumption per CNY10,000 GDP declined by 18.9% compared to a target of 22%. In 2009, its energy intensity improved to 1.072 tsce per CNY10,000 of GDP . Despite improving the energy intensity, the underinvestment in energy efficiency and the existence of many energy-intensive industries in the province provide significant opportunities for further energy intensity reductions through targeted investment.
The existing industrial energy efficiency financing mechanisms in Shandong have mainly benefited small projects primarily through ESCO involvement. While the ESCO concept has been operative in PRC since 1998 its implementation was rather slow and limited to small-scale industrial energy efficiency improvements, e.g., retrofitting of air-conditioners, lighting, boilers, pumps and motors. A large financing gap exists for medium- and large-sized energy efficiency projects that involve all or part of an industrial manufacturing process for an industry. Three key barriers have impeded investment: (i) lack of familiarity with the latest energy efficient technologies, combined with the enterprises' perception of production interruptions and/or loss of revenues; (ii) difficulties for commercial banks to assess cash-flow benefits and forgo collateral for such investment projects which do not generate additional revenues; and (iii) lack of capacity for evaluation and risk assignments for energy conservation investments by commercial banks. Limited market-based incentive mechanisms to reward investors for reducing emissions through energy efficiency also discourage investors. These market imperfections warrant targeted public interventions.
Several measures have been adopted in designing this project to address these barriers. Accordingly, the FIL modality was chosen to (i) allow multiple rollover of the ADB loan, thus, providing larger investments for energy efficiency over the loan tenor, (ii) build knowledge and capacity of provincial government and selected financial intermediary in evaluation and risk assignments for energy efficiency transactions, (iii) reduce transaction complexities and costs due to familiarity and experience gained by the project management office (PMO) and the financial intermediary from the initial subprojects, and (iv) enhance governance and improve safeguard compliance for energy efficiency investments beyond the first batch of subprojects.
Consistent with the Strategy 2020 goals, the project encourages private sector investments. In the first batch, both selected subprojects are private enterprises. The emphasis on technological innovation featured in the design of the project and selection of the first batch of subprojects is expected to be maintained and further intensified for future subprojects. The project design includes an innovative package of financial incentives and rewards to encourage continued participation and enhance interest from similar industrial enterprises thus, leveraging additional private investments. In addition, to encourage and explore ESCO participation in future subprojects specific recommendations and actions are being finalized under the TA (footnote 1). This, combined with the recent PRC Circular No. 25 of the State Council Development and Reform Commission on ESCO policy, will enhance engaging ESCO companies for the project .
The selected two private enterprises Golden Yimeng Group (Golden Yimeng) and Dongying Lufang Metallic Materials (Lufang) are both industrial leaders in their respective areas and are proposing state-of-the-art energy efficiency and renewable energy technologies. The Golden Yimeng sub-project includes expanding the biogas capturing system to generate power and supply heat; using biowaste as fuel and to produce organic fertilizers; waste heat recovery and energy conservation from various process units; and using heat from solar parabolic concentrators to supply a 6-megawatt steam turbine to generate electricity. This will be the first such large-scale industrial solar application in the PRC. Lufang is among the top six copper producers in the PRC. Lufang sub-project will support and supplement the development of a zero coal copper ore smelting furnace an innovative technology. This technology will set the new market entry standard for future copper smelters and have a profound impact on energy efficiency and emission reduction efforts.
The China Everbright Bank (CEB), Jinan branch, was selected as the FI through a competitive bidding process conducted in May 2010. The involvement of CEB, a commercial bank, in rolling over the fund will bring in sound banking expertise and governance in energy efficiency lending. It will also strengthen cooperation between the government agency (the PMO) and the domestic financial institution, which may encourage them to work together beyond the project and expand investments in this high priority area for the government.
To ensure that high standards with regard to due diligence and assessment are followed beyond the first batch of subprojects, ADB, the Government of the PRC, Shandong provincial government (SPG), and CEB have agreed on a set of technical, financial, economic, social, and safeguards criteria for selecting subborrowers and subprojects. This will assist the PMO and CEB in managing risks in future subprojects.