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CALCULATION OF INCREMENTAL COSTS
GLOBAL ENVIRONMENTAL CONTEXT
1. Chinese researchers have predicted that a doubling of CO2 will have a negative impact on rice, wheat, and cotton production in China because of the combined effects of higher temperatures, increased soil evaporation, and more frequent and severe storms.1 This prediction is consistent with the most recent modeling work by the IPCC, which estimates that agricultural production could fall by 6-8 percent worldwide, and by 10-12 percent in developing countries, with a doubling of atmospheric CO2 concentrations. Rising sea level is another concern for China and other countries with large populations living in low-lying coastal plains. According to studies by Chinese researchers, a 1-meter increase in sea level, when combined with storm surge and the astronomical tide, will flood areas below a 4-meter contour line in China's coastal plains, including the entire cities of Shanghai and Canton.
2. Carbon dioxide from energy consumption currently accounts for roughly four-fifths of China's total greenhouse gas emissions. Without exceptional policy measures to stem the increase, carbon dioxide emissions would increase roughly three-fold between 1990 and 2020, based on a high-growth scenario.2 The increase in GHG emissions in this scenario is due primarily to a rise in coal consumption from 1.05 billion tons in 1990 to about 3.1 billion tons in 2020. In order to accommodate the three-fold increase in energy use by China, and still keep global CO2 emissions at their 1990 levels3, the rest of the world would need to cut its CO2 emissions by 8 percent in the year 2000 and 40 percent by the year 2020.
BROAD DEVELOPMENTAL GOALS
3. Primary energy use will need to increase significantly over the coming decades in order for China to achieve average GDP growth rates slightly lower than those of the past decade. Coal is the only domestic energy resource that could meet such a large increase in energy demand. In order to achieve increases in energy supply, but avoid additional pollution-related impacts from coal burning (including the threat of global climate change), China will need to improve energy efficiency in all sectors, particularly within industry, invest heavily in clean-coal technologies and pollution control equipment, and expand the use of non-coal energy sources, including renewables.
BASELINE
4. Despite the virtual lack of coal-fired industrial boilers in other industrial countries, the demand for these boilers in China is expected to continue and even grow over the coming twenty years. The Chinese Ministry of Machinery Industry estimates that the annual demand for industrial boilers -- both new and replacement -- is currently 85-100 thousand tons of steam per hour (ktph), and will rise to 100-125 ktph by 2000, and to 130-160 ktph by 2010.4 Cumulative production of new and replacement boilers over the next twenty years would be in the range of 2.1 to 2.6 million tph. For the purposes of the incremental cost analysis, the project scope includes the production of 364,000 tph over 20 years, representing between 16-20% of total expected added capacity. In the absence of global environmental considerations, this capacity would be met with existing standard boiler designs.
5. Given increasingly strict standards for industrial boilers with respect to local pollutants (TSP and SO2), it is expected that existing boiler designs would need to be retrofitted with additional pollution control equipment (such as cyclones and baghouses for TSP removal) and some new technologies would gain market share (such as domestically-designed FBC boilers for SO2 control). Currently, most industrial boilers can only meet the country's lowest standards (Class III), and thus can generally not be located in urban and residential locations (where Class I and II standards apply). However, without global environment considerations, energy efficiency improvements in existing boilers are expected to be modest.
GEF ALTERNATIVE
6. The GEF alternative proposes to improve the efficiency of industrial boilers in China, largely through the transfer from abroad of advanced technologies, designs, and production methods. In the course of project identification and development, a total of nine boiler models representing the entire spectrum of sizes and applications have been identified for improvement. Using a competitive bidding process stressing both technical and financial criteria, leading Chinese boiler producers have submitted applications to produce one or more of the nine boiler models. At full production the project would annually produce 26 ktph of new boiler capacity, resulting in a cumulative capacity over 20 years of 364,000 tph.
7. Because the enterprises that have applied to participate in the project are among the leading boiler manufacturers in China, the efficiency of their existing boilers are already above 70% -- well above the national average of 60-65%. Nonetheless, through the introduction of advanced technologies and designs from abroad, the efficiency of existing boilers from advanced producers can be raised to nearly 80%. More importantly, once these advanced designs are demonstrated and put on the market, other producers are likely to adopt the new designs and in the process raise the overall thermal efficiency level of the industry. Dissemination will be supported through the establishment of a high efficiency boiler development center.
SYSTEM BOUNDARY
8. One of the major problems with the production of more energy efficient equipment such as boilers is that while the research and development costs and the associated commercial risks accrue to producers, the benefits accrue largely to the users through lower operating costs. In addition to appropriation problems, there is a long time lag (12 years) between the initial project investment and the time that total energy savings are sufficient to recoup the investment. Nonetheless, because of the significant national benefits that accrue to boiler consumers in the form of fuel savings, it is necessary for the system boundary to be drawn to include both producers and consumers of energy efficiency equipment.
INCIDENTAL DOMESTIC BENEFITS
9. The baseline and alternative projects both provide the same level of industrial boiler steaming and hot water capacity (ktph). However, the alternative project provides consumers with lower coal fuel bills. These benefits are readily quantifiable and provide a direct financial benefit to consumers in fuel savings over the lifetime of their boilers. In the cost-benefit analysis of the boiler subprojects, a portion of consumers' fuel cost savings has been transferred to boiler producers in the form of higher boiler sales prices and thus higher sales revenues (see paras. 12-14 and footnote 5).
10. Other domestic benefits of the alternative project include the reduction in particulate and sulfur that result from both energy efficiency and improved emission controls. While methodologies for quantifying in financial terms the human health and other benefits of reduced TSP and SO2 emissions, it is clear that the domestic benefits are quite large.
COSTS
11. The incremental cost of the efficient industrial boilers project has been calculated as the difference between the baseline ("without project") and the GEF alternative ("with project"). Two sets of incremental costs have been calculated: (a) the theoretical economic incremental cost to the country as a whole, and (b) the observable incremental cost to boiler producers along with incremental costs of removing barriers to effective dissemination.
12. Theoretical Economic Incremental Cost. The total (discounted) capital costs of producing 364,000 tph of boiler capacity under the baseline is estimated to be US$1,836 million (constant 1994 dollars), while the total (discounted) capital costs of producing the same quantity of more energy efficient boilers under the GEF alternative is estimated to be $2,132. For consumers, there is a second important difference between the old and the new boilers; i.e., the cost of operating the boilers, most importantly, coal fuel. The (discounted) operating costs, including coal consumption, of the baseline are estimated to be US$11,015 million. In the absence of uncertainty and risk, perfect information, and fully functioning capital markets, the (discounted) operating costs of the GEF alternative are estimated to be US$10,676 million. While the incremental capital costs of the project as a whole are $295 million, theoretical operational cost savings are $339 million. Thus, while not obtainable without removing these barriers, there is a theoretical negative economic incremental cost of the GEF project of US$43 million. Under this theoretical incremental cost analysis, consumers are assumed to sacrifice all of their consumer surplus to boiler producers in order for producers to earn a normal rate of return (12%) on their investment.
13. Incremental Costs of Boiler Production and Barrier Removal. The largest component of the incremental cost is the cost to the nine subproject boiler enterprises for acquiring advanced international technologies, adapting them, and for commercial demonstration in China. Detailed "with" and "without" project cost-benefit analyses have been prepared for each of the nine boiler subprojects to serve as the "baseline" and "GEF alternative" for calculating the project's incremental costs. Limited technical renovation investment has been included in the "without project" case, reflecting the prevailing situation in the industrial boiler market. Cost-benefit analysis was also conducted for boiler consumers for each of the nine boiler subprojects for the purpose of calculating the project rate of return, the payback period of the boiler investment, and the maximum boiler price for consumers; i.e., the price at which the rate of return and payback period for the "with" and "without" project cases are equal.
14. 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.5 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 benefits from costs to producers, there is a net incremental cost of approximately $30.2 million6 to boiler producers for undertaking the GEF alternative. Details of the costs of the subprojects are given in Annex Tables 1.1 and 1.2.
15. A second set of costs of the GEF alternative is for overcoming the numerous barriers to the broad dissemination of the advanced boilers throughout China and to ensure that the improved boilers are adopted by consumers. Training programs for industry representatives, dissemination and marketing activities, targeted policy studies, are described in the text and are critical to the sustainability of the project. An efficient boiler development center is proposed to be established to provide information throughout China on advanced boiler designs, undertake studies for boiler promotion, such as on standards and effective marketing, and work with provincial and municipal governments to ensure that advanced boilers are adopted. The incremental cost of these components -- those that would not be undertaken without the project -- has been estimated at $1.5 million.
16. The project management office (PMO) for the project would be housed within the efficient boiler development center, and would oversee both monitoring and evaluation and project administration functions. The incremental cost of these activities over the 6 year life of the GEF project is estimated at $1.135 million.
GLOBAL ENVIRONMENTAL BENEFITS
17. The global environmental benefits of the efficient industrial boiler project are given in Annex Table 1.3.
2 The high-growth scenario assumes the Chinese economy grows at an average annual rate of 8.0 percent between 1990 and 2020. See China: Issues and Options in Greenhouse Gas Emissions Control, Summary Report, December 1994.
3 Intergovernmental Panel on Climate Change; see Houghton, Jenkins, and Ephraum, 1990.
4 Pre-Feasibility Study on High Efficiency Industrial Boilers, China Greenhouse Gas Study, Subreport No. 11, August 1994.
5 The difference in costs between (a) the theoretical economic incremental cost to the country, and (b) the financial incremental cost to producers, is that (a) assumes that boiler producers earn a normal profit on sales (12% rate of return on investment) resulting in the price of boilers to consumers set at the maximum (i.e., no consumer surplus), while (b) sets prices at levels the market can bear (approximately 20% less than price producers need to earn a 12% rate of return). In addition to rate of return and payback analyses conducted for producers and consumers, future boiler price estimates were generated based on detailed surveys of the current industrial boiler market
6 The incremental cost was calculated at 256.7 million yuan. The 1995 exchange rate of 8.5 Yuan/US$ was used in the analysis.