World Bank Document · 2016. 7. 19. · FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation November 14, 1994 MEMORANDUM

Document of

The World Bank

FOR OFICAL USE ONLY

Report No. 13694

PERFORMANCE AUDIT REPORT

CHINA

DAQING OILFIELD-GAOTAIZI RESERVOIR DEVELOPMENT PROJECT(LOAN 2231-CHA)

ZHONGYUAN-WENLIU PETROLEUM PROJECT(LOAN 2252-CHA)

AND

KARAMAY PETROLEUM PROJECT(LOAN 2426-CHA)

NOVEMBER 14, 1994

Operations Evaluation Department

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS(annual averages)

Currencv UJnit = Yuan (Y)US$1.00 = Y5.8

ABBREVIATIONS AND ACRONYMS

CNOOC - China National Offshore Oil CorporationCNPC - China National Petroleum CorporationCNTIC - China National Technical Import CorporationDPAB - Daqing Petroleum Administration BureauERR - Economic Rate of ReturnKOC - Karamay Oil CompanyGOC - Government of ChinaMIS - The Management Information SystemMOPI - The Ministry of Petroleum IndustriesOECD - Organization for Economic Cooperation and DevelopmentPCR - The Project Completion ReportSPCMI - State Planning Commission Machiniery and Inspectioni WingTOR - Terms of ReferenceZPEB - Zhongyuan Petroleum Exploration Bureau

FISCAL YEAR

January 1, - December 31

FOR OFFICIAL USE ONLY

THE WORLD BANKWashington, D.C. 20433

U.S.A.

Office of Director-GeneralOperations Evaluation

November 14, 1994

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Performance Audit Report on ChinaDaqing Oilfield-Gaotaizi Reservoir Development Project

(Loan-2231-CHA)Zhongyuan-Wenliu Petroleum Project (Loan 2252-CHA)Karamav Petroleum Proiect (Loan 2426-CHA)

Attached is the Performance Audit Report on China - Daqing Oilfield-Gaotaizi ReservoirDevelopment Project (Loan 2231-CHA), Zhongyuan-Wenliu Petroleum Project (Loan 2252-CHA) andKaramay Petroleum Project (Loan 2426-CHA) prepared by the Operations Evaluation Department.

The objectives of these projects were to enhance exploration success and petroleumproduction levels, through the introduction of modern oilfield technology and through training in the useof these advanced technologies.

Although there were significant delays in implementation, due primarily to the complexinstitutional arrangements required for foreign procurement in China at that time, the projects all mettheir major objectives. In particular, sophisticated technologies were effectively transferred. Bothproduction levels and reserves increased substantially under all projects. Safety practices studies, drillingand completion studies and modern technical training facilities for oilfield workers and technicians werealso introduced.

The outcome of all three projects is rated as highly satisfactory, their sustainability aslikely, and their institutional impact as substantial.

This document has a restricted distribution and may be used by recipients onLy in the performance ofI their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

FOR OFFICIAL USE ONLY


CHINA



ANDKARAMAY PETROLEUM PROJECT

(LOAN 2426-CHA)

TABLE OF CONTENTS

Page No.

PREFACE ................................................. iBASIC DATA SHEETS .iiEVALUATION SUMMARY .xi

The Daqing Project .xiThe Zhongyuan Project .xiiThe Karamay Project .xiiiCommon Findings and Lessons .xvConclusions .xviii

DAQING OILFIELD-GAOTAIZI RESERVOIR DEVELOPMENT PROJECT I

1. BACKGROUND .I

2. PROJECT OBJECTIVES . 2

3. PROJECT IMPLEMENTATION AND RESULTS. 2

Exploration. 3The Prototype Production Station. 3Studies. 3Training .5

This report was prepared by Richard L. Bemey, Principal Evaluation Officer, with inputs fromFernando Zuniga-Rivero, Petroleum Engineering Consultant and secretarial services by LomaSibblies.

This document has a esicted distribution and may be used by recipients only in the peormanc of therofficial duties. Its contents may not otherwise be disclosed without World Bank authrzton.

TABLE OF CONTENTS (Cont'd.)Page No.

4. PROJECT ISSUES . ......................................... 5

Delays in Project Implementation . ............................. 5The Prototype Petroleum Production Station ...................... 6Choice of Technology ...................................... 6

5. PROJECT OUTCOME AND SUSTAINABILUTY. .................. 8

ZHONGYUAN-WENLIU PETROLEUM PROJECT . ................... 9

1. BACKGROUND ............................................ 9

2. PROJECT OBJECTIVES . .................................... 9

3. PROJECT IMPLEMENTATION AND RESULTS ................... 10

4. PROJECT ISSUES . ......................................... 11

Findings and Lessons Learned from PCR ......................... 11Delay in Project Implementation ............................... 11The Reservoir Study ........................................ 14The Management Information System (MIS) Study .................. 16

5. PROJECT OUTCOME AND SUSTAINABILITY . .................. 16

KARAMAY PETROLEUM PROJECT .. 17

1. BACKGROUND ............................................ 17

2. PROJECT OBJECTIVES . .................................... 17

3. PROJECT IMPLEMENTATION AND RESULTS . ................. 18

Light Oil .............................................. 18Heavy Oil at Karamay ...................................... 18Heavy Oi! at Liaohe ........................................ 19Training Center ............. .............................. 19Studies . ................................................ 19

TABLE OF CONTENTS (Cont'd.) Page No.

4 ISSUES. ............ ................................... 20

Findings and Lessons of PCR Report ............................ 20Procurement ............................................. 21The Shift to Heavy Oil Development ............................ 21Training ................................................ 22Technical Studies .................... . ...................... 23Lessons Learned from Implementation of Studies ................... 24

5. PROJECT OUTCOME AND SUSTAINABELITY . .................. 25

CONCLUSIONS FOR ALL THREE DEVELOPMENT PROJECTS. ...... 26

Bank Lending for Oil Development in China ...................... 27

Annex 1: Comments from China National Petroleum Corporation .... ........ 28


CHINA




(LOAN 2426-CHA)

PREFACE

This is a Performance Audit Report (PAR) for the Daqing Oilfield-Gaotaizi ReservoirDevelopment Project involving a Bank Loan of US$162.4 million, US$161.9 of which was disbursed;the Zhongyuan-Wenliu Petroleum Project, involving a loan of US$100.8 million, US$96.8 of which wasdisbursed; and the Karamay Petroleum Project, involving a loan of US$100.3 million, US$89.5 of whichwas disbursed. The main objective of the three projects was to transfer modem oilfield technology toChina and to increase petroleum production at the three fields. Project Completion Reports were issuedon May 21, 1991, December 10, 1992, and June 29, 1992, respectively.

The PAR was written in the Operations Evaluation Department (OED). To prepare it, OEDreviewed the Presidents' Reports, Staff Appraisal Reports, legal documents, transcript of the BoardProceedings, Bank files, and held discussions with Bank staff associated with the project. An OEDmission visited China in October 1993, where it held discussions with Govemment officials, officialsof the China National Petroleum Company (CNPC), China National Offshore Oil Corporation(CNOOC), and the management of the Daqing Petroleum Administration Bureau (DPAB), ZhongyuanPetroleum Exploration Bureau (ZPEB), and the Karamay Oil Company (KOC). The effective andpleasant cooperation and assistance of these Chinese authorities, and particularly of CNPC, is gratefullyacknowledged.

The PCRs, which were of acceptable quality, concluded that the implementation of all threeprojects was successful and that the results were all satisfactory. This audit report supplements thePCRs. It makes recommendations on ways that similar projects could be implemented with less delaysin the future, and highlights the practices used for the successful transfer of technology and recommendsthat these practices be used in similar circumstances elsewhere.

Following standard OED procedures, this draft PAR was sent to the Borrower for comment.Comments received are attached as an annex to the PAR.

i.


CHINADAQING OILF[EDI-GAOTAIZI RESERVOIR DEVELOPMENT PROJECT

(LOAN 2231-CHA)

BASIC DATA SHEET

KEY PROJECT DATA

Apraisal Expectation Actual

Total Project Cost (US$ million) 674.3 332.0Loan Amount (US$ million) 162.4 161.9Economic Rate of Return 91 %

*As the net cash flow was positive from the first year of project implementation, the ERR (on an annualizedbasis) was an infinite rate of return. See p. 19 of PCR.

CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENTS(USS million)

Bank FY 1298 124 198S 1986 1287 1288 .12 1990 12mAppraisal Estimate 30.0 120.0 150.0 162.4 162.4 162.4 162.4 162.4 162.4Acual - 7.0 57.2 97.5 127.5 138.3 146.2 160.2 161.9

Actual/Appraisal, % - 5.8 38.1 60.0 78.5 85.2 90.0 98.7 99.7

PROJEC TIMETABL

Original ActualIdentification Mission 9/81Appraisal Mission 2-3/82Negotiations 12/82Board Approval 1/25/83Loan Signature 3/8/83Loan Effectiveness 9/8/83Closing Date 6/30/86 6/30/90Date of Final Disbursement 8/8/90Loan Completion 10/31/90

iii

(Staff Weeks)

Through Appraisal 48.1Through Board Approval 147.2Supervision 148.9

Total 344.2

MISSION DATA

Stage Date Number of SW in Specialties Performance(mo/yr) Persons RI Reesented La Ratng Zk

Through appraisalIdentification 9/81 5 3 E, FA, PEAppraisal 2/82 7 4 E, FA, G, PE

Appraisal throughboard approval

Post Appraisal 5/82 7 3 PE, PSSupervision

1* 9/83 1 3 PS2* 3/84 2 4 E,PS3 4/84 4 2 FA, PE, G 24* 10/84 1 3 PS5 12/84 4 3 FA, G, PE,PS6* 5/85 1 4 PS7* 9/85 1 2.5 PS8* 4/86 1 3 PS9 6/86 3 1 FA,PE,G I

10* 10/86 1 1 PS11 2/87 3 2 FA,PE,G 112* 3/88 1 1 PS13 6/88 3 1 FA,PE,PS14 7/89 2 1 PE,PS I

* Procurement supervision in combination with other projects./A: E: Economist L: 1: No significant problem

PE: Petroleum Engineer 2: Moderate ProblemFA: Financial Analyst 3: Major ProblemPS: Procurement Specialist 4: Major problem not adequately addressedG: Geologist

iv

RELAT'ED BANK PROJECTS

Purpse Year of Cths(ommenltsAppDroval

Zhongyuan Wenliu Petroleum Petroleum 1983 Satisfactory Completion date:Project (Ln. 2252-CHA) exploration/ Original: 12131/86

development, Actual: 12/31/90TA and training.

Karamay Petroleum Petroleum 1984 Satisfactory Completion date:Project (Ln: 2426-CHA) exploration, Original: 3/31/89

heavy oil Actual: 3/31/91recovery, TAand training.

Weiyuan Gas Field Gas field 1985 Satisfactory Completion date:Technical Assistance rehabilitation Original: 6/30/90Project (Ln: 2580-CHA) TA and training. Actual: 6/30/92

Liaodong Bay Petroleum Gas field 1986 Completed Completion date:Project (Ln: 2708-CHA) appraisal, TA Satisfactorily Original 12/31/89

and training Actual: 12131/89

Sichuan Gas Development Support of 1994 Completion date:and Conservation Project sector restruc- Original: 2001.(Ln: 3716-CHA) turing, pricing, Loan approved: 3/94

rationalization,increasing gasproduction &conservation.

v


CHINAZHONGYUAN-WENLIU PETROLEUM PROJECT

(LOAN 2252-CHA)

BASIC DATA SHEET

KEY PROJECT DATA

A&Draisal Expectation Actual

Total Project Cost (USS million) 499.8 427.0Loan Amount (USS million) 100.8 96.8Economic Rate of Return 74% 49%

CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENTS

FY 1984 1985 1986 1987 1988 1989 1990 1991Appraisal Estimate (USS million) 27.0 85.0 100.8Actual (USS million) 0.8 18.4 35.7 58.3 63.6 81.6 85.7 96.6Actual/Appraisal, % 3 22 35 58 63 80 85 96

PROJECT TIMETABLE

Original ActualIdentification Mission 9/81Preappraisal Mission 9/82Loan Negotiations 2/83Board Approval 3/29/83Loan Signature 4/15/83Loan Effectiveness 8/9/83Closing Date 12/31/86 12/31/90Date of Final Disbursement 5/3/91

vi

STAFF INPUTS(Staff Weeks)

ActualThrough Appraisal 116.5Appraisal Through Board Approval 16.9Supervision 183.1

Total 317.5

MISSION DATA

Stage of Date Number of SW in Specialties PerformanceProiect (mo/vr) persons field reRresented /a Status /b

Through Appraisal 09/81 5 20 PE, PS, FA, G, EIdentificationAppraisal 02/82 6 24 PE, G, FA, E, two C

Appraisal throughBoard Approval 05/82 3 9 E, FA, PE

Post Approval 09/83 3 9 E, FA, PESupervision

1 09/83 2 5 PA, PE 12 03/84 4 24 G, GP, FA, PE 23 09/84 3 6 G, FA, PE 24 05/85 4 8 G, FA, PE, PS 25 12/85 3 6 G, FA, PE 26 09/86 3 10 G, GP, PE 27 02/87 3 3 G, PS, PE 28 10/87 3 6 PS, FA, PE 29 03/89 3 3 PS, PE, G 210 05/91 4 3 PS, PE, FA, C

/a: PE: Petroleum Engineer /bL 1: No significant problemG: Geologist 2: Moderate ProblemC: consultants 3: Major ProblemGP: Geophysicist 4: Major problem not adequately addressedPS: Procurement SpecialistFA: Financial Analyst

vii

RELATED BANK PROJECTS

Year of Sau CommentsPu=pse A=royal

Daqing Oilfield-Gaotaizi Reservoir 1983 Satisfactory Completion date:Resorvoir Development Development Original:6/30/86Project (La: 2231-CHA) TA and trining. Actual: 6/30/90

Karamay Petroleum Petroleum 1984 Satisfactory Completion date:Project (L: 2426-CHA) exploation, Original: 3/31/89

heavy oil Actua: 3/31/91recovery, TAand tmaining.

Weiyuan Gas Field Gas field 1985 Satisfactory Completion date:Technical Assistance rehabilitation Original: 6/30/90Project (La: 2580-CHA) TA and training. Actual: 6/30/92

Libaong Bay Petroleum Gas field 1986 Completed Completion date:Prject (La: 2708-CHA) appraisal, TA Satisfactorily Original: 12131/89

and training. Acual: 12131/89

Sickxun Gas Developmet Support of 1994 Completion dae:n Conevation Projct sector restruc- Original: 2001.

(La: 3716-CHA) turing, pricing Loan approved: 3/94rationaliution,increasing gasproduction andconversation

viii


CHINAKARAMAY PETROLEUM PROJECT

(LOAN 2426-CHA)

BASIC DATA SHEET

KEY PROJECT DATA

Appraisal Expectation Actual

Total Project Cost (US$ million) 753.5 964.85Loan Amount (US$ million) 100.3 89.5Economic Rate of Return Not Calculated 31%

CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENTS

Bank FY 1985 1986 1987 1988 1989 1990 121.Appraisal Estimate (US$ million) 8.0 40.0 94.0 100.3Actual (US$ million) 4.3 29.1 40.7 65.3 77.9 86.1 89.5Actual/Appraisal, % 53.8 72.8 43.3 65.1 77.9 85.8 89.2

PROJECT TIMETABLE

Original ActualIdentification Mission 5/2/83Appraisal Mission 9/15/83Negotiations 4/16/84Board Approval 5/29/84Loan Signature 6/25/84Loan Effectiveness 9/25/84Closing Date 3/31/89 3/31/91Date of Final Disbursement 7/25/91

ix

STAFF NPITTS(Staff Weeks)

Through Appraisal 43Through Board Approval 64Supervision 154

Total 261

MISSION DATA

Stage of Date Number of SW in SpecialtiesProject (mo/yr) persons field reRresentedThrough Appraisal

Identification 5/83 7 4 E, PE, G, FAAppraisal 9/83 6 3 PE, G, FA

Appraisal throughBoard Approval 5/84Post Approval

Supervision1 7/84 2 1 PE, G2 10-11/84 5 2 PS, PE, PA3* 10/84 1 3 PS4* 12/84 1 2 PS5* 5/85 1 4 PS6 5/85 5 1 G, FA,PE, PS7* 9/85 1 3 PS8 11/85 3 3 PS, FA, G9 3-4/86 1 4 PS10 8-9/86 5 2 G, FA, PS

PE, FA11 2/87 4 1 G, PE, PS

FA12 10/87 3 2 PS, FA, PE13* 3/89 3 1 PS, G, PE

* Procurement supervision in combination with other projects, but only SW which were spent for supervisionof Karamay Petroleum Project have been counted.

E: EconomistFA: Financial AnalystPS: ProcurementG: GeologistPE: Petroleun Engineer

x

RELATED BANK PROJECTS

Purpose Year of Status CommentsApproval

Zhongyuan Wenliu Petroleum Petroleum 1983 Satisfactory Completion date:Project (Ln. 2252-CHA) exploration/ Original: 12/31/86

development, Actual: 12/31/90TA and training.

Daqing Oilfield-Gaotaizi Reservoir 1983 Satisfactorv Completion date:Reservoir Development Development. Original: 6/30/86Project (Ln: 2231-CHA) TA and training. Actual: 6/30/90

Weiyuan Gas Field Gas field 1985 Satisfactory Completion date:Technical Assistance rehabilitation Original: 6/30/90Project (Ln: 2580-CHA) TA and training. Actual: 6/30/92

Liaodong Bay Petroleum Gas field 1986 Completed Completion date:Project (Ln: 2708-CHA) appraisal, TA Satisfactorily Original: 12/31/89

and training. Actual: 12/31/89

Sichuan Gas Development Support of sector 1994 Completion date:and Conservation Project restructuring, pricing Original: 2001.(Ln: 3716-CHA) rationalization, Loan approved

increasing gas 3/94production andconservation.

xi


CHINA




(LOAN 2426-CHA)

EVALUATION SUMMARY

INTRODUCTION

1. China's petroleum production increased off-setting the anticipated decline in domesticfrom 10 million tons per year in 1960 to nearly oil production; second, to provide a vehicle for110 million tons in 1980, but declined during the introduction of modem technology through1981-1982. There had been no new major the financing of modem equipment and thediscoveries in the 1970's and there was little technical assistance in optimum utilization oflikelihood that future large discoveries could this equipment; and third, to upgrade theaugment production during the 1980s. Offshore operating, technical, and managerial skills ofexploration, with its high risks and specialized China's oil industry personnel. Three regionsrequirements, had been contracted out to were identified as being of prime importance tomultinational oil companies. The Ministry of MOPI: Daqing, Zhongyuan and Karamay. OverPetroleum Industries (MOPI) came to the the three-year period, 1981-1984, the Bankconclusion that in the short and medium term, identified, and subsequently financed, a projectincreased output would have to be achieved in each of these areas.primarily through expanded production in andaround existing oilfields, and this could only be THE DAQING PROJECTaccomplished through the introduction ofmodem production and exploration technology. 3. The Daqing Oilfield project was theIt was within this framework that the first Bank operation in the petroleum sector inGovernment of China (GOC) approached the China. Daqing was the largest petroleum fieldBank for assistance in rehabilitating and in China, where a successful rehabilitationmodernizing China's petroleum sector. program would have an important impact on

China's aggregate petroleum output.2. The Bank's petroleum sector lending inChina had three basic objectives: First, to 4. The broad objectives of the Daqingimprove the development of the known Oilfield Project were: (i) to increase oilhydrocarbon-bearing structures, thereby partially production through the introduction of modem

xii

equipment and technology; (ii) to establish a the oilfield region for skilled workers and fortraining center for skilled workers and another engineers. The program has been extremelyfor engineers and technical staff; (iii) to successful, with more than 10,000 engineersincrease reserves through the support of an and skilled workers already having completedexploration program using modem seismic data various three-month to one-year courses.gathering and processing equipment.

Outcome and SustainabilityImplementation and Results

9. The Audit finds that the Daqing project5. The project was executed by the outcome was highly satisfactory, as all its majorDaqing Petroleum Administration Bureau objectives were met. Its institutional(DPAB). Implementation started slowly, but development impact was substantial. Thecompletion of most of the physical components transfer of technology that took place during thewas delayed by only one year. Studies project, appears to be fully sustainable. Theencountered delays from two to seven years, Audit is in full agreement with the PCR that theand training over four years. potential economic benefits from continuing the

field development of the Gaotaizi reservoir is6. The project was highly successful in sustainable. Output from the field is expectedintroducing modem production and exploration to be greatly increased as a result of thetechnology, and resulted in substantially enormously positive results of the Enhanced Oilincreased oil production and oil reserves. Both Recovery Study. All covenants were compliedmodem equipment and technology assistance with.were important in this process. As a result ofthe recommendations made in the reservoir THE ZHONGYUAN PROJECTengineering, well drilling and well completionstudies implemented under the project, 10. The Zhongyuan project was the secondcumulative production in 1989 was 40% higher Bank project in support of the Modernization ofthan appraisal estimates. Improved exploration the Chinese petroleum sector. Modemtechniques resulted in an increase in proven technology was critical in the Zhongyuanreserves. The expanded size of the oilfield oilfields because the reservoirs were quite deep,resulted in a 50% increase in proven reserves with high pressure gas zones, which madeand a greatly expanded development program. drilling very difficult. Its geology was quiteDPAB also extended its exploration efforts into complex, and the primitive seismic equipmentareas where its old equipment could not have being used made the identification of optimumbeen used, and increased its ratio of successful drilling locations problematic.wells from 32% to 48%.

11. The broad project objectives of the7. Five studies related to the transfer of Zhongyuan project were: (i) to increase oil andoilfield technology were implemented under the gas production and reserves in the project area;project. The Reservoir Engineering Study, (ii) to enhance operational efficiency andDrilling and Completion Practices Study and strengthen ZPEB's institutional capabilities; andSafety Study formed the core of the program (iii) to extract LPG from the associated naturalfor transfer of technology outside the gas which was being flared.technology embodied in equipment purchases.

Implementation and Results8. A large part of the training wasaccomplished through the creation, for the first 12. The project met with substantial delaystime, of formal technical training centers within in all components, with the exception of the

xi,ii

drilling of explorati'on wells. In spite of the it in Chinese characters was not available atdelays, all the major project objectives were that t-ime.successfully achieved: ZPEB was able toimplement the full development of the South 17. The Reservoir Study of the SouthWenliu oilfield; one hundred and twenty million Wenliu oilfield was to establish an optimizedtons of additional proven reserves were long-term field development plan. ZPEBconfirmed in the East Wenliu structure and are continually requested further work from thenow under development; and the gas processing consultant, and the study never did come toplant for the recovery and treatment of LPG closure. Nevertheless, ZPEB reported that theproducts from the associated natural gas was process of sending their technical staff to theinstalled and is fully functional. consultant's headquarters to assist in

implementing technical studies proved to be an13. Action was taken on environmental effective method for technology transfer. Theproblems that were identified. During an early experience gained has enabled ZPEB to designsupervision mission, Bank staff noted that its own reservoir model with independentlycorrosion from untreated water had caused purchased software.serious production and environmental problems.T'he Bank recommended, and ZPEB agreed, to Outcome and Sustainabilityamend the scope of the project to include thedesign and construction of a water treating 18. Despite the long delays, the projectfac ilIity. In addition, the study's outcome was highly satisfactory, in meeting itsrecommendations for upgrading water handling major goal to transfer exploration andtechniques have been disseminated to, and production technology to ZPEB, and assistapplied in, oilfields throughout the country. ZPEB increase its oil and gas production. It

had an important environmental impact. It14. Four consultancy-assisted studies enabled ZPEB to stop the wasteful flaring ofintroduced modem oilfield practices and natural gas, and it found solutions duringtechnology. The Safety Practices Study implementation for eliminating environmentallyrecommended actions needed to bring the field unsound water processing practices. Itsoperations safety practices in line with Western successes in improving ZPEB operatingsafety standard. These recommendations were capacity are likely to be sustainable. It wasimplemented. less successful in helping ZPEB to improve its

institutional management capabilities. Its15. The Drilling And Well Completion institutional development impact was thereforePractices Study and demonstration program judged negligible. All covenants wereanalyzed problems that had been encountered in complied with.the past and proposed ways to overcome them.These recommendations were also acted upon, THE KARAMAY PROJECTwith excellent results in ter-ms of faster, moreefficient drilling and greatly improved 19. The Karamay Project, in Xinjiangcompletion rates. Province, was the third and last Bank project to

focus on increasing oil production. As in the16. The Management Information System preceding two projects, the project objectiveStudy, which was to assist with the introduction was the provision of technical assistance toof modern oilfield management techniques, enhance the region's long-term productivity.including modem cost accounting was canceled, Karamay's major problem was that it hadprimarily because the technology to implement massive reserves of heavy oil that it had not

been able to develop with its existing

xlv

technology. The project was therefore tailored studies and with contractor on the use of newto the requirements for developing and equipment. Both proved to be quite effective.enhancing its heavy oil recovery program, in However, the overseas technical trainingaddition to updating light oil exploration and program for engineers and managers was ableproduction technology. The project also to train only one quarter of people expected.included a Gas Utilization Study for gas that Inadequate early attention to development ofhad been recently discovered offshore in language skills was a major contributifg factor.Southern China and an EOR study for heavy oilfrom the Liaohe oilfield in Liaoning Province. 25. Studies: The geological and reservoir

studies were successfully implemented,Implementation and Results although with many delays, with the assistance

of foreign consultants. The costing study was20. Procurement started slowly, with successfully implemented by a group of localproblems of coordination among the three consultants from other oil enterprises. The Gasconcered entities, KOC, CNTIC and MOPI. Utilization study was implemented by CNOOC,

the executing agency for this project21. Light Oil: The exploration program for component. It was only partially successful, inlight oil was less successful than expected that it did not fully analyze issues related toduring appraisal. The resultant increase in optimum utilization of the gas.production of light oil was about half thatexpected at appraisal. Project Restructuring

22. Heavy Oil at Karamai : Support for the 26. The Bank worked closely with KOC inheavy oil program was greatly expanded. restructuring the project to take advantage ofInstead of supporting experimental pilots, the new opportunities in the rapidly changingproject was restructured to support a program conditions in the oilfield. Funds were shiftedfor full development of KOC's heavy oil from the light oil project component to supportresources, including the drilling of over 1100 a greatly expanded program to drill delineationwells. The development program has been and development wells - an increase from thehighly successful. Production, which was original 160 to a final 1,126 - and aoriginally projected to remain at below 50,000 concomitant growth in surface facilities,tons per ylear, rose to 1.4 million tons in 1990 particularly steam generators. It was anand is expected to increase to more than 2.7 extremely successful endeavor; however, themillion tons per year by 2000. project resulted in a significant change in the

project scope, and the changes were made2 3. HeavY Oil at Liaohe: The studies for without formnal agreement by Bank Managementthe Liaohie heavy' oil pilot development program or the Board.showNed that while the program was feasible, thedevelopment would not be economically viable Outcome and Sustainabilityfor Liaohe heavy' oil unless the internationalprice wxas over $30 per barrel. The large scale 27. The Audit finds that the outcome of thepilot wvas abandoned. Karamay project was highly satisfactory, as it

met its objectives of introducing modem oilfield24. Training: A training center for oilfield technology, including management, financialworkers was built after some delay. The center costing and control, and of assisting KOC tois operating effectively. The other major increase its oil production levels. Institutionalsource of training in the use of new technology development, particularly that related towas on-the-job training with consultants on financial management and controls also appears

xv

to have been significant. The benefits are likely 3 1. Internal Procedures: The Chineseto be sustainable in the future. All covenants internal procurement approval process requiredwere complied with. coordination of approvals by five separate

Chinese agencies. Even after the Bank raisedCOMMON FINDINGS AND LESSONS the issue, it was unable to convince the GOC to

make the changes needed to establish effectiveDelays in Project Implementation inter-agency working groups to facilitate the

process, although commitments to do so were28. Delays of up to two years were made numerous times.encountered in the procurement of goods andservices for all three project. There were, of 32. Lesson: The Bank should have insistedcourse, many causes for these delays, including: that these problems be resolved as a condition(i) the Borrower's inexperience in working with of moving forward with the Karamay project.Bank procurement procedures; (ii) cumbersome Both the Bank and the GOC have learned frominternal clearance procedures, combined with a their experiences with these projects. In thefragmentation of responsibilities among various recent Sichuan Gas Project, the Government hasGovernment agencies; and (iii) protracted organized a Coordination Committee to ensurecontract negotiations after the contractor had that procurement processing remains on track.been selected, particularly on revised terms ofreference for the studies and related revised fee 33. Protracted Negotiations: Substantialstructures, but also for some specialized delays also took place after the winningequipment. There are, however, actions that the contractor had been decided. Negotiations onBank can take to lesson the impact of these the final terms and conditions of contracts oftencauses of delay. took up to 10 months, an exceptionally long

time by Bank standards. For consultant studies,29. Inexperience: The Bank had some negotiations took up to 18 months.anticipated the need for a new Borrower tolearn Bank procedures and established a 34. Recommendation. The Bank shouldprocurement training program early in the consider intervening in contract negotiationsproject cycle. This training program was when they extend beyond what would appear toestablished many years later, after the problems be normal and appropriate, and the work to bebecame pervasive in all Bank lending done is on the critical path, or when a patternoperations. of extended negotiations begins to develop. In

such cases the Bank could request a30. Recommendation: Training programs participatory role as a neutral facilitator, to keepfor Bank procurement and loan disbursement the negotiations in line with the scope of thepractices should be part of any project with a original bidding documents. Such interventionnew borrower or new executing agency, could be particularly important when the resultsparticularly important when the country itself of the consultant study are considered criticalhas only recently joined the Bank Group, and is for proper implementation of other projectstill unfamiliar with international bidding and elements.Bank procedures. Where inter-agencycoordination is necessary, a procurement Choice of Technologyseminar should be given exclusively for all thestaff who will have to Nvork together on the new 35. All three projects purchased drillingproject. In this way the seminar could initiate simulators for their training institutions.the process of teamwork that is needed for Technology was changing rapidly in the area.efficient project implementation. The winning bidder in the Daqing and Karamay

xvi

projects committed himself to technology implementation. These delays were caused byupgrades that were not yet in production. The differences in opinion about what the terms ofequipment arrived without the computer reference required and changes in the studyhardware and software needed operate it. scope during the course of implementation.Before the problem could be resolved, the Bank staff should have carefully monitoredcontractor went bankrupt. No replacement changes in study scope and should have workedequipment has been bought, and, as a result, all with both parties to ensure that unrealisticthree centers have been unable to provide this expectations did not push the consultant toimportant training. promise more than could be delivered. When

Borrowers have had little or no experience in36. Lesson: Bank borrowers should working with foreign consultants, Bankpurchase only proven technology. Bidding technical staff should join interim projectdocuments and equipment specifications should reviews.reflect this requirement before they areapproved. 41. Safety studies are an important part of

the modernization of any oilfield operation,37. Lesson: Borrowers who have had little particularly when the operation has had little orexperience with commercial law, may need no contact with modem western safetyadvice from the Bank on the limitations of legal standards. The direct involvement of oilfieldremedies for resolving commercial disputes, operating staff greatly improved the likelihoodincluding, when appropriate, advice to accept of effectively implementing the studythe loss and start over again, so that the project recommendations.objectives can be met.

42. Cost accounting and studies can beTurnkey Contracts successfully implemented by local groups, if

these groups have access to the techniques used38. The failure of the prototype monitoring in more advanced countries. There are manystation in the Daqing project once again advantages to implementing such studies withdemonstrates that the coordination and quality local groups, the most important of which maycontrol function is probably the most difficult be that it establishes the internal "ownership" ofpart of the construction of any plant. the results which makes dissemination and

adoption much more likely.39. Recommendation: This complexmanagement function should not be performed 43. The Gas Utilization Study wasby a Borrower with only limited experience in intended as a vehicle for improving theworking with foreign suppliers on complex coordination between gas producing and usingprojects. In such cases, turnkey contract should agencies. It did not achieve this goal. Such abe used to ensure the completion of study is unlikely to be successful if only one ofcomplicated facilities that require efficient the concerned agencies is involved in itsinterfacing of many different pieces of execution. If Bank staff are unavailable forequipment, such as the Daqing prototype detailed supervision of studies undertaken bysurface facility. local groups, arrangements should be made to

have an international expert review the study atImplementation of Studies critical junctures, since there may be no internal

critical review process.40. Study Delays: In addition to the delaysin initiating consultant studies, there werefrequent delays and extensions during

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Transfer of Technology. program should include training of managementand business staff, in addition to technical staff,

44. The transfer of advanced oilfield even if these staff are not expected to take other

operating technology and know-how was the foreign courses, since technical stal'l'rarely have

most important achievement of the three time to translate materials when thcy return.

projects. The transfer took place through manychannels, the most important of which were: CONCLUSIONS

i) The training, both in China and abroad, 47. The three projects of this Audit reflect

provided by the suppliers of modern the first stage of the development of Bank

and sophisticated equipment purchased assistance to China's Petroleum Sector. They

under the project. focused primarily on introducing moderntechnology, the training of staff at all levels in

ii) The involvement of the implementing the use of this technology, and utilizing this

agency's staff in working with the technology to improve the productivity and

consultants, both in China and at the safety of oilfield operations and to increase the

consultant's headquarters, on the volume of oil that could be produced from

various consultant studies, particularly these fields. In these endeavors they were

those related to reservoir analysis, highly successful. New technology was

oilfield practices and safety. successfully introduced, training ccnters wereestablished to train staff in all aspects of

iii) Consultant assistance, at the oilfields, modern oilfield operations, productivity was

with the initial implementation of the increased, and a great deal more oil was

recommendations emanating from their produced than would have been possible using

studies, particularly in the areas of the older, outdated technology previously

drilling and oilfield practices and safety available.standards.

48. The results of the technical assistance

iv) The establishment of permanent and staff training must be ranked as the most

training institutions for skilled workers important of achievements of these projects, in

and the training of teachers, both in spite of the delay caused in the actual trainingChina and overseas, in the specialized programs. The capabilities of all three

curricula and teaching methodology operating companies and their contribution

most effective for learning advanced towards the petroleum industry in China have

oilfield techniques and practices. been significantly enhanced by theimplementation of these projects.

45. Recommendation. The Bank shouldconsider replicating in other countries the same 49. The Audits highlight the issues of the

approach to transfer of technology that it has effectiveness of transfer of technology in this

utilized so successfully with the China project because it believes that the techniques

petroleum loans. used here could be and should be replicated inother countries, particularly those with large but

46. Training Abroad. When foreign technically behind the times petroleum

language training is needed for the effective industries. It also highlights the difficulties

transfer of technology, it should be included as encountered when the Bank starts project

a specific project component. It must be lending operations in a new country, and

implemented early, since it is always a time- proposes ways in which these difficulties could

consuming process. This language training be overcome in other countries that have

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limited experience working with foreign with the petroleum authorities. If the Banksuppliers and are unfamiliar with the Bank's intends to continue to be active in the Energyprocurement procedures. sector, it will need a broader understanding of

sector priorities.Sector Review and Policy Dialogue

Bank Lending for Oil Development in China50. The projects were appraised withoutany significant sector review or sector policy 53. The Bank stopped virtually all oil sectordialogue. By sidestepping sector policy issues, work in China after the introduction of OMSthe Bank was able to assist in speeding up the 3.82 in 1984. The next two petroleum projectsrate of technical progress in the petroleum were for technical assistance.sector at a critical juncture in China's petroleumdevelopment efforts. The Audit believes that 54. OMS 3.82 takes the position that Bankthis flexible approach greatly enhanced the loans should not support wildcat explorationBank's effectiveness in making an important efforts. The high risk nature of suchimpact on the sector. undertakings make them unsuitable for the use

of borrowed funds, and international oil51. There were, however, many sector companies have a clear comparative advantageissues where a policy dialogue might have in technology know-how. It also takes ahelped sector performance, such as lack of reasonable position on countries with limitedautonomy at the enterprise level, price controls petroleum activities. However applying theand quantitative target setting instead of same approach to resource development toefficiency oriented profit criteria. In the early countries with a very large, established sector,1980s, China was not ready to make policy with a massive petroleum production needs tochanges in these areas. China is now moving be reconsidered. In these limited number ofrapidly towards a market oriented, decentralized cases, a substantial part of the proven reserveseconomy. The Bank has been working with the should, and will, continue to be developed byGovernment on evaluating alternative ways of national enterprises, since it is unlikely thatrestructuring the petroleum sector to increase these operations can be transferred to foreigncompetition among foreign operating entities, joint ventures on reasonable terms. It makesand to introduce competition. An expanded little sense in these cases to refuse to assist insector policy dialogue is needed, particularly in the transfer of modern technology to thesethe areas of pricing and investment priorities. national operators.

52. The Bank has done little in the way ofbasic sector work. The original choice ofprojects was left to the Chinese authorities(MOPI), both with no independent effort madeto prioritize the sector's investment program.Given the time constraints, the size of thecountry, and the significance of the first threeprojects, this approach was a reasonable way toinitiate a sector lending program. A sectorpolicy review was implemented in 1990, but itlooked mostly at the institutional issues. Therehas yet to be a review of the country's majoroil and gas operations. The Bank is, therefore,unable to discuss sector investment priorities


CHINA


1. BACKGROUND

1.1 China's petroleum production increased from 10 million tons per year in 1960 to nearly 110million tons in 1980, but declined during 1981-1982. There had been no new major discoveries in the1970's and there was little likelihood that future large discoveries could augment production during the1980s. Offshore exploration, with its high risks and specialized requirements, had been contracted outto multinational oil companies. The Ministry of Petroleum Industries (MOPI) came to the conclusionthat China was unlikely to increase petroleum production, or even maintain it at its current level, as longas the industry continued to use outdated technology. In the short and medium term, increased outputwould have to be achieved primarily through expanded production in and around existing oilfields, andthis could only be accomplished through the introduction of modem production and explorationtechnology. It was within this framework that the Government of China (GOC) approached the Bankfor assistance in rehabilitating and modernizing China's petroleum sector.

1.2 The Bank's petroleum sector lending in China had three basic objectives: first, to improve thedevelopment of the known hydrocarbon-bearing structures, thereby partially off-setting the anticipateddecline in domestic oil production; second, to provide a vehicle for the introduction of moderntechnology through the financing of modem equipment and the technical assistance in optimumutilization of this equipment; and third, to upgrade the operating, technical, and managerial skills ofChina's oil industry personnel.

1.3 The Daqing project was identified by MOPI as among the highest priority projects formodernizing the operations of petroleum industry, primarily because Daqing was the largest petroleumfield in China, where a successful rehabilitation program would have an important impact on China'saggregate petroleum output. The introduction of modern technology would be a critical element in thesuccess of Daqing's long-term operations, because the company's largest oilfield had been fullydeveloped, and in spite of an extensive secondary recovery effort through water flooding, productionwas beginning to decline. Oil was no longer free flowing but had to be pumped, and the limits ofsecondary recovery efforts through water flooding were becoming apparent. Furthermore, oil had beendiscovered in a much deeper horizon, but Daqing lacked the technology needed to efficiently drill andcomplete production wells at this depth.

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2. PROJECT OBJECTIVES

2.1 The broad objectives of the Daqing Oilfield Project were:

(a) To augment oil production through the development of the Gaotaizi reservoir;

(b) To establish a training center for skilled workers and another for engineers andtechnical staff,

(c) To increase reserves through the support of an exploration program using modemseismic data gathering and processing equipment; and

(d) To implement this program in addition to the imported equipment, DPAB wouldreceive technical services in the form of six studies covering all aspects of oilfieldoperation practices;

2.2 One of the most innovative features of this project - and the following two petroleumdevelopment projects - was the effort made to maximize the impact of the transfer of modemtechnology, which was the central project goal. First, it was agreed that Bank funds would be used onlyfor the import of equipment that embodied modem technology, such as drilling, cementing, anddown-hole testing equipment, and a seismic data processing center, instead of standard oilfield materialssuch as tubing and drill bits. Second, it was agreed that, since the transfer of technology required anextended learning process, all equipment purchase contracts would include a requirement that theequipment supplier provide on-the-job training in the use of the equipment, both in China and in foreigncountries where the equipment was in operation.

2.3 The project was appraised in February 1982, approved by the Board in January 1983, andcompleted in October 1990, four years after originally planned. Project implementation and results wereessentially as described in the PCR, and are summarized in the following section. There were no sectorpolicy conditionalities associated with the loan.

3. PROJECT IMPLEMENTATION AND RESULTS

3.1 The Gaotaizi reservoir was successfully developed. It proved to be substantially larger andmore productive than originally anticipated. On the basis of the exploration data generated duringproject implementation, the estimated areal extent (size) of the oilfield has increased substantially, ashave the reserve estimates. Reserves, which had originally been estimated by the Bank consultants at32 million tons, and by DPAB at 51 million tons, are currently estimated at 76 million tons. Theextended size of the field resulted in an expanded development program with the first phase, coveredunder the project, implemented between 1982 and 1985, and a second phase, which was outside theproject scope, implemented between 1986 and 1989.

3.2 As a result of the recommendations made in the reservoir engineering, well drilling and wellcompletion studies implemented under the project, production has also increased significantly aboveappraisal estimates, both on a per well and a total basis. Average daily production peaked at 26 tons

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per well in 1985, compared with the appraisal estimates of 19 tons, and total field output peaked at 5.0million tons in 1987 and 1988 compared with the appraisal estimate of 3.8 million. Accumulatedproduction in 1989 was 24.8 million tons, compared with the projected 17.7 million tons.

Exploration

3.3 The introduction of state-of-the-art seismic data acquisition, processing and interpretationequipment and technology and the training associated with its introduction contributed to a markedimprovement in DPAB's success in identifying prospective locations for its exploration drilling program.As a result, the success ratio increased from 32% to 48%, under much more difficult terrain than couldhave been worked on with the older equipment.

The Prototype Production Station

3.4 The facility was completed three years behind schedule, primarily as a result of delays in thecompletion of the consultancy study. The first design was for a facility more expensive than estimatedat appraisal, primarily because the optimal size suggested by DPAB was to handle 100 wells, far largerthan expected at appraisal. The cost for this first design was almost four times the amount allocatedunder the project -- US$22 million versus US$6 million. Since the foreign exchange was not availableunder the project and MOPI was unable to allocate the additional funds required for the prototype, thedesign was changed to a much smaller, 20 well plant. Since this was a prototype plant, the smallerfacility was considered appropriate.

3.5 DPAB engineers leamed how to use up-to-date standards and specifications for the design ofoilfield collection and gathering stations, and are now able to design all their own facilities. However,because some of the contractors delivered faulty equipment, the monitoring aspects of the facility neverworked. As a result, the prototype facility was unable to meet its target of improving the standards formonitoring individual well operating conditions and production levels on a continuous basis.

Studies

3.6 Five studies related to the transfer of oilfield technology were implemented under the project.The Reservoir Engineering Study, Drilling and Completion Practices Study and Safety Study formedthe core of the program for transfer of technology outside the technology embodied in equipmentpurchases. While all the studies were successfully implemented and were highly successful intransferring modem oilfield technology to DPAB, they all suffered from delays ranging from two to sixyears.

3.7 The Reservoir Engineering Study was completed two years late. Its objectives were, first,to design a master plan for development of the Gaotaizi reservoir and, second, to provide training inadvanced methods for designing and implementing reservoir modeling, so that they could continue toplan future reservoir development programs. Some of the study results were of considerable importancefor improving the way DPAB implemented its field development program. The study identified oilbearing sands that had previously been omitted from production plans. Completion of wells in thesesands has been an important element in allowing Daqing to maintain its planned production levels. Thestudy also identified additional reservoirs that had not been previously identified by DPAB, therebyproviding additional suitable locations for drilling new production wells.

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3.8 The study also proved highly successful as a vehicle for the transfer of technological know-how.DPAB staff engineers were able to use the methodology they had learned to create their own reservoirmodel, using software they had obtained with the purchase of their computer. With this new softwarethey were eventually able to update the development plan for the Gaotaizi reservoir, and to model otherreservoirs in the area.

3.9 However, the study failed to meet the expectations of DPAB, in that it did not establish amasterplan for the development of the Gaotaizi oilfield. By the time the final report was delivered toDPAB, its broad recommendations had already been incorporated into DPAB's thinking, but itsmasterplan was already obsolete. Because the contract had failed to include the purchase of theunderlying modeling software and hardware needed to rerun the model, DPAB was unable to updatethe model results to take into account new drilling and production data that had accumulated since theoriginal field data had been transmitted to the consultant. The report on the model and theaccompanying proposed development masterplan was, therefore, useful only as a historical document.

3.10 Lesson. It is imperative that the operating company should acquire the hardware and softwareneeded to continue to carry out their own reservoir modeling requirements, even if this equipment isincompatible with the modeling equipment used in their training.

3.11 The objective of the Drilling and Completion Study was to identify the ways DPAB couldimprove their oilfield development technology. It was started two years behind schedule and wascompleted almost four years behind schedule. One of the main delays was caused by an inaccuratedescription in the Terms of Reference for the study of DPAB's drilling needs. The problem appearsto have been that the terms of reference were completed by a consultant who had only visited theDaqing oilfield briefly, and had only a limited knowledge of the geological conditions encounteredthere. As a result many changes had to be made, both before and after the bidding took place, to ensurethat the study would be one that would fit more appropriately DPAB's requirements. For instance, oneof the components was an evaluation of water jet injection drilling, which could not be used in Daqing'sgeological conditions, because it would damage the reservoir. Nevertheless, even with the long delays,the final results were impressive. Using the recommendations of the study, DPAB was able to reduceits drilling and well completion time by 30%. Perhaps even more importantly, its deep drillingproblems were satisfactorily resolved, enabling it to drill and complete successfully 122 new deep wells,where the previous five attempts before the study was undertaken had all been abandoned beforecompletion.

3.12 Lesson: Studies designed to evaluate and recommend improvements for oilfield andmanagement practices need to be designed jointly with the executing agency's management. Suchstudies can be implemented far quicker when they are designed in a way that establishes ownershipon the part of the agency to be studied. This process should be accomplished during appraisal, or, atthe latest, before project effectiveness, if they are to be implemented on schedule. If Terms ofReference are being revised during contract negotiations with the successful bidder, close supervisionis also advisable.

3.13 The Safety Study was delayed by four and a half years. Much of the delay was due to thelengthy intemal procedures needed to establish an acceptable Terms of Reference, and the longnegotiations required to reach agreement with the contractor on an acceptable study program. The studywas further delayed by the need to change contractors, (and renegotiate the study program) after theoriginal winning bidder went bankrupt. Eventually this study proved to be a highly effective tool for

5

improving safety standards at Daqing. Comparable statistics for before and after the study show adecline in serious accidents after the study recommendations were implemented to less than one-thirdtheir pre-study level.

3.14 The study was particularly innovative because it involved the operations personnel at everylevel. It was organized as a joint activity between the consultants and numerous operational levelcommittees. Eight foreign experts held 34 separate group forums to identify and discuss over 500 safetyissues. The final documentation was fully translated into Chinese to facilitate its dissemination tooperating personnel. Study results were instrumental in the modification of the design of the Daqingmulti-purpose oil tank storage facility, in the design of fire fighting facilities, and in the use of saferdrilling techniques.

3.15 Lessons. Safety studies are an important part of the modernization of any oilfield operation,particularly when the operation has had little or no contact with modem western safety standards. Thedirect involvement of oilfield operating staff greatly improved the likelihood of effectively implementingthe study recommendations.

Training

3.16 Training of both engineers and skilled workers was an important part of the project's objectivefor the transfer of technology. A large part of the training was accomplished through the creation, forthe first time, of formal technical training centers within the oilfield region for skilled workers and forengineers. The training centers have been staffed by personnel sent abroad under a program financedby the project to learn the most up-to-date technical standards and teaching methods, and by foreignexperts who were invited to Daqing to design courses and specifically train local staff. The programhas been extremely successful, with more than 10,000 engineers and skilled workers already havingcompleted various three-month to one-year courses.

4. PROJECT ISSUES

Delays In Project Implementation

4.1 Delays of up to two years were encountered in the procurement of goods and services for theproject. There were, of course, many causes for these delays, including: (i) the late start in preparingand issuing the draft bidding documents by outside consultants; (ii) the borrowers inexperience inworking with Bank procurement procedures; (iii) cumbersome internal clearance procedures combinedwith a fragmentation of responsibilities among various Government agencies; (iv) protracted contractnegotiations after the contractor had been selected, particularly on revised terms of reference for thestudies and related revised fee structures;

4.2 In addition, there were frequent delays and extensions in the implementation of consultantstudies, due to differences in opinion about what the terms of reference required and sometimes due tothe desire on the part of the Borrower to expand the scope of the original terms of reference.

4.3 This was the first Bank loan to the petroleum sector, and one of the first Bank loans to China.One should therefore not be surprised that implementation went less smoothly than planned, as both the

6

Bank and the Borrower learned about the operating practices, procedures, and policies of the other. ThePRC concluded that the problems of lack of experience were exacerbated by inadequate interagencycoordination and cumbersome internal clearance procedures.

4.4 The PCR suggested that the Bank could have helped reduce the delays in consultancy studiesby assisting the project entity in drafting a better focused scope of work in terms of reference forconsultant studies, and that these draft terms of reference should have been prepared before the fieldappraisal rather than during project supervision. The Audit is in full agreement with these observations.However, it found that there are a number of additional operational lessons that can be learned fromthe experience with these three first petroleum projects in China. These lessons may help to minimizeprocurement delays in the future, both in China and in other countries new to the Bank's procedures.

The Prototype Petroleum Production Station

4.5 The objective of this prototype facility was to introduce design technology and equipment whichwould optimize the processing of crude oil, water and natural gas from the reservoirs (to minimize theenergy requirements to heat and transport them). It was also supposed to introduce an accurate methodfor continuous metering of individual production and injection wells so that reservoir performance couldbe monitored and optimized. As discussed below, this project component met with several difficultiesand was never made operational.

4.6 Although DPAB had never worked with foreign contractors, it decided, with the Bank'sconcurrence, to act as its own prime contractor for this project component, coordinating all procurementand construction activities. Based on the advice of the consultants, the project was subdivided into ninebidding packages, with DPAB taking responsibility for interfacing the nine contractors. Thisimplementation structure could have worked if all contractors had performed to the letter of theircontracts. Unfortunately, the key contractor, who was to provide the central computer monitoring unit,failed to provide the necessary computer software. Other less critical pieces of equipment also failedto work as required. As a result, DPAB was unable to make the facility function.

4.7 Lesson. For complicated facilities that require efficient interfacing of many different pieces ofequipment it is important to have a turnkey contract with a prime contractor who will have sufficientfinancial commitment in the project to ensure that all the equipment works together properly.Furthermore, when things do go wrong, it is much easier to initiate corrective action, with litigation ifnecessary, for one large contract where there are clearly defined responsibilities, than it is on a numberof small contracts where contractors can invariably blame the problem on the interface with the othercontractor's equipment.

4.8 Recommendation: The coordination and quality control function is probably the most difficultpart of the construction of any plant, and should not be left to an implementing agency who has hadonly limited experience in working on such projects with foreign suppliers.

Choice of Technology

4.9 The Daqing and Karamay projects together purchased five drilling simulators for their traininginstitutions, all from the same supplier. Unfortunately, the equipment arrived without the electronicsthat were necessary to allow them to function. The experts who were supposed to arrive to put themtogether never showed up, and sometime shortly thereafter the supplying company went bankrupt. No

7

replacement equipment has been bought, and all these centers have been operating without this centraltraining activity. When it was discovered that the supplier had declared bankruptcy, the Borrowers triedto find other ways to make the equipment function, even at a limited level. Unfortunately, this couldnot be done, since the time and cost needed to make it work is much greater than the cost of new digitalequipment. A number of lessons and recommendations can be drawn from this unfortunate experience.

4.10 Lessons: The choice of appropriate technology may require specialized technical knowledge.The technologies employed by the two suppliers who bid for these contracts were very different. Onewas an analogue technology and the other was a digital technology. The digital technology, which wasmuch newer, was claimed to be able to accomplish more than the older analogue technology, but wassomewhat more expensive. A comparison of the effectiveness of the two technologies was particularlyimportant in this case because the bids were relatively close, and the question of which was the lowestevaluated bidder hang from the evaluation of the various claims and counter-claims about what eachpiece of equipment could do. However, in reviewing the bids, Bank staff appears to have made noeffort to ensure that an adequate evaluation and comparison was made of the effectiveness andusefulness of the two technologies.

4.11 Recommendation: For the procurement of highly complex technical equipment, where Bankstaff have no expertise, a special effort should be made to ensure that the appropriate technology isused. When radically different technologies are being proposed for accomplishing the same goal, Bankshould insist that a knowledgeable, independent consultant is hired to compare the advantages and thedisadvantages of each.

4.12 Lesson: Bank borrowers should not be used as experimental subjects for new and untestedequipment when there are alternative, tested equipment available in the market. The lowest evaluatedbidder offered an "advanced" model that was not yet on the market. As a result, it was difficult for theexecuting agency to judge the validity of claims about how the machine would function. In the end,the machine offered by the successful bidder failed to function at all, most probably because thecompany, under extreme financial pressure, rushed it into production before all the bugs had beenworked out.

4.13 Recommendation: Bidding documents should require verification that equipment with similarcharacteristics and capabilities should be in operation. Preferably, similar equipment should havealready been sold and installed so that claims about its effectiveness can be assessed. If the equipmentis a new model, especially one with expanded capabilities, then the contract should stipulate thecondition that it be tested and approved by the borrower, or an independent agency representing theborrower, as a condition of acceptance of the export letter of credit.

4.14 Lesson: The Borrowers have been unable to resolve the problem, and still are without thisimportant piece of training equipment. After finding that the company was bankrupt and could not meetit's obligations, the Borrowers spent most of their efforts on attempting to salvage the uselessequipment, and have yet to consider purchasing substitute equipment. Essentially, those involved appearto have lost sight of the project goal, which was to provide a complete training facility for skilledworkers. To ensure that this goal was accomplished, the Bank should have advised the Borrowers torecognize the loss, and to purchase similar equipment from another producer. If loan funds were nolonger available under the project, the Borrower should have replaced the equipment with its ownresources, to fulfill its obligations to complete the project.

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4.15 Recommendation. Borrowers in non-market oriented countries, who have had little experiencewith commercial law in their own country or in developed countries, may need guidance on what theycan and cannot expect in the resolution of commercial disputes. When major problems arise, the Bankshould provide assistance in suggesting the most likely successful strategy to follow, including, whenappropriate, to accept the loss and start over again, so that the project objectives can be met.

5. PROJECT OUTCOME AND SUSTAINABILITY

5.1 The Audit finds that the project results were highly satisfactory and successful in meeting allits major objectives. Its institutional development impact was substantial. The transfer of technologythat took place during the project, through the program of studies, the introduction of modem oilfieldequipment and the training related to its operation and maintenance, and the technical training for skilledworkers and engineers all appear to be fully sustainable. The Audit is in full agreement with the PCRthat the potential economic benefits from continuing the field development of the Gaotaizi reservoir issustainable. Output from the field is expected to be greatly increased as a result of the enormouslypositive results of the Enhanced Oil Recovery (EOR) study undertaken under the project. It is expectedthat one of the methods tested under this study (the polymer flooding) will increase the recoverablereserves from Gaotaizi (from 30% of oil in place to 44%). DPAB has sufficient confidence in this newtechnology to invest over $200 million in a polymer production plant.

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1. BACKGROUND

1.1 China's petroleum production increased from 10 million tons per year in 1960 to nearly 110million tons in 1980, but declined in 1981 and 1982. There had been no major discoveries in the1970's, and the Ministry of Petroleum industries (MOPI) came to the conclusion that China wasunlikely to maintain its petroleum production level, let alone increase it significantly if it continued touse the outdated technology. MOPI also decided that, while there was great potential for finding newlarge sources of supply from prospective off-shore areas, there was little likelihood that new largeonshore discoveries would add to production during the next decade. Therefore, it concluded thatincreased production would have to be achieved primarily through expanding the production in andaround existing oilfields, which would only come through the introduction of modem production andexploration technology. It was within this framework that the Government of China (GOC) approachedthe Bank for assistance in rehabilitating and modernizing China's petroleum sector.

1.2 The Bank's lending in the petroleum sector in China was to have three basic objectives: firstly,to develop the known hydrocarbon bearing structures in order to partially offset the anticipated declinein national oil production. Secondly, providing a vehicle for the introduction of modern technologythrough the financing of modem equipment and the technical assistance in optimum operation of thisequipment. Thirdly, in training and upgrading the operating, technical and managerial skills of China'soil industry personnel.

1.3 The Zhongyuan project was one of the first three projects identified by the Government ofChina as among the highest priority projects (the other two were Daqing and Karamay) for modernizingpetroleum practices, where the introduction of modern technology would be a critical element in thesuccess of the country's oil development program. Modern technology was critical in the Zhongyuanoilfields because the reservoirs were quite deep with high pressure gas zones, which made drilling verydifficult, and the field geology was quite complex, so that the primitive seismic equipment being usedmade it difficult to identify optimum drilling locations.

2. PROJECT OBJECTIVES

2.1 The broad project objectives of the Zhongyuan project were to:

(i) increase oil and gas production and reserves in the project area;

(ii) enhance operational efficiency and strengthen ZPEB's institutional capabilities throughstaff training and the modernization of their oilfield operating practices; and

(iii) extract LPG from the associated natural gas which was being flared.

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3. PROJECT IMPLEMENTATION AND RESULTS

3.1 All the major project objectives were successfully achieved, in spite of the long delaysexperienced during implementation.

3.2 The transfer of advanced oilfield operating technology was the most important achievement ofthe project. The transfer took place through many channels, the most important of which were:

* The importation of modem and sophisticated equipment and the related trainingprovided by suppliers of equipment and services, both in China and abroad.

* The involvement of ZPEB counterpart staff working with the consultants on thereservoir, oilfield practices and safety studies.

The field trips arranged by the equipment manufacturers and the study consultantswhich acquainted ZPEB staff with actual operating practices in western oilfields, mostlyin the US and Canada.

* Consultant assistance with the initial implementation of the recommendations emanatingfrom their studies, particularly in the areas of drilling and oilfield practices and safetystandards.

* The establishment of a training center for 3000 workers a year and the training ofteachers, both in Zhongyuan and overseas, in the methodology for preparing thespecialized curricula for teaching advanced oilfield techniques and in the utilization ofmodem audio-visual and simulation model for assisted teaching methods.

3.3 In addition to the transfer of technology, the project also reached its major physical targets, asdescribed in the PCR and summarized below:

ZPEB was able to implement the full development of the South Wenliu oilfield;

One hundred and twenty million tons of additional proven reserves were confirmed inthe East Wenliu structure and are now under development;

The gas processing plant for the recovery and treatment of LPG products from theassociated natural gas was installed and is fully functional.

3.4 Environmental impact became a serious concern during project implementation. During theearly supervision missions, Bank staff noted that corrosion from untreated water had caused seriousproblems in the tubing of both injection and production wells, and in the production pipelines, whichwas increasing production costs and also producing environmental pollution, as the number of waterand oil spills began to increase. The Bank recommended, and ZPEB agreed to amend the scope of theproject to include a study on the appropriate methods for treating water produced by the field and forconstructing a water treating facility. Once the water treatment study had been completed, a new watertreatment facility was constructed to treat both the produced and injection water. Recommendations

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for upgrading water handling techniques have been disseminated to and applied in oilfields throughoutthe country.

3.5 Four consultant assisted studies were also expected to introduce modem oilfield practices andtechnology, as follows:

* A Safety Practices Study, which was to bring the field operations safety practices inline with Western safety standard;

* A drilling and well completion practices study and demonstration program which wasto analyze the problems that had been encountered in the past and propose ways toovercome them;

* A reservoir analysis of the South Wenliu oilfield, which would include an optimizedlong-term development plan for this field;

* A Management Information System, which was to assist with the introduction ofmodem oilfield management techniques, including modem cost accounting;

3.6 The first two of these consultant studies were highly successful; the third had many problemsand was never completed; and the fourth was never initiated.

4. PROJECT ISSUES

Findings and Lessons Learned from PCR

4.1 Procurement. Factors that contributed to the early project delays were ZPEB's lack offamiliarity with the Bank's procurement procedures, cumbersome internal processing and clearanceprocedures, and extended delays in contract negotiations. Coordination of clearances among threeentities, (ZPEB, CNPC and CNTIC) made the process particularly difficult. Recommendation: In thefuture the central authorities should delegate procurement authority to the local implementing entity.

4.2 Studies: The Bank should help the executing agency prepare focussed terms of reference forall studies during project preparation, rather than leave this to subsequent supervision missions. Thiswould greatly accelerate the implementation processes.

4.3 Petroleum Prices: Appropriate domestic pricing policies for oil and gas need to be establishedto assure that production companies can remain financially sound.

4.4 The Audit agrees with all these conclusions and recommendations. Other issues, not fullycovered in the PCR are discussed below.

Delay in Project Implementation

4.5 The project met with substantial delays in all components with the exception of the drilling ofexploration wells. Import of oilfield equipment was delayed on average by two and a half years, studies

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were delayed by about four years, construction of the building for the training programs, the computercenter and the laboratory were delayed by about five years, and operation of the LPG plant was delayedby almost six years.

4.6 Learning Bank Procedures. Bank supervision missions and the PCR tended to lay most of theblame for delays on the inexperience of the various Chinese agencies in working with Bankprocurement procedures. While this inexperience played an important role in perpetuating the delays,it is neither a complete explanation nor an adequate justification for them. To the extent that it was amajor contributing factors it could have been substantially overcome if the Bank had recognized it earlyand taken action to overcome it by establishing a procurement training program in the project cycle.This training program was established many years later, after the problems became pervasive in allBank lending operations.

4.7 Coordination of Chinese Agencies. The problem of the Borrower's lack of experience withBank procurement procedures was exacerbated by the cumbersome Chinese intemal procurementapproval process, which required coordination of approvals by five separate Chinese agencies. Theexecuting agency (ZPEB) had to obtain the approval of the Ministry of Petroleum Industry (MOPI) andthe Machinery and Electrical Equipment Import Inspection Wing under the State Council for alltechnical aspects of the bids. The National Import Agency (CNTIC) had to approve the specificationsand issue the bidding documents. All four agencies were jointly responsible for evaluating the bids andnegotiating details with the winning bidder. Finally, after the contract was written by CNTIC, theNational Committee for Contracts had to approve it.'

4.8 The bidding documents, the bid appraisals and the award of the final contract also had to bereviewed by the Bank. All had to be translated into Chinese, reviewed, then translated back intoEnglish for communication to the Bank. Furthermore, since the approval process was a sequential one,in which Bank approvals were requested only after all other approvals were obtained, the wholesequence of translations and approvals having to be repeated when the Bank requested changes toconform with its standards. Finally, when the time came for payments to be made, the National Bankof China had to also review the documentation and approve each step.

4.9 Even after the problems came to light during the first year of project implementation, the Bankwas unable to convince the GOC to make the changes needed to improve the situation. The GOC wasunwilling to remove CNTIC's monopoly position on foreign trade activities. Nor would the GOCestablish an effective inter-agency working groups to facilitate procurement processing.

4.10 The lack of urgency in resolving these types of problems can be seen in the agreement duringnegotiations, that the project team for ZPEB would be in place within six months after Boardpresentation (i.e. by September 1983, a year after the Appraisal). In fact, it was not until the firstprocurement supervision mission in September 1983, that the institutional procedures were reviewedby Bank staff. And in March 1984, a procurement mission noted that procurement was delayed as aresult of the Borrower's inexperience with Bank procedures. By this time the Bank had recognized theproblems created by the lack of coordination among the responsible agencies, but it appears to havedone little to find a resolution to them besides exhorting the GOC to set up a coordination committee.

'The China National Petroleum Corporation (CNPC), which has taken over the role of MOPI, hasnoted that "the approved procedure among the five agencies was not exactly like that expected" inthis simplified description.

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The problem was supposed to be resolved by the reorganization of CNTIC in March 1985, but Bankmissions continued to complain about inexperienced and overworked staff. With such a complexprocess, it is not surprising to find that there were substantial delays in the initial project phases, delaysoften of twelve months and more.

4.11 Lesson: This coordination problem should have been identified at the time of appraisal andaddressed early on in the project cycle. Although it was already recognized that these procedures wouldbe cumbersome, the Appraisal Mission failed to analyze the implications of these complex institutionalarrangements in terms of institutional interface requirements among the institutions through eachprocedural step.

4.12 Lesson: After a close inspection of supervision mission Back-To-Office Reports andAide-Memoires, the Audit concludes large supervision missions and new project preparation missionsvisited China, they held few, if any, discussions with senior level officials about the actions needed tobe taken for institutional strengthening. The Audit therefore concludes that one of the major reasonsthat this problem remained unresolved for so long was that the lone petroleum project procurementspecialist was, for all practical purposes, the only person actively engaged in trying to establish theinstitutional change needed to improve the situation. Although he was able to bring the problem to theattention of the Government, he was unable to get the Government to commit itself to a specific courseof action to achieve institutional reforms that could improve interagency communications.

4.13 Both the Bank and the GOC have learned from their experiences with these projects. Many ofthe procurement problems associated with these projects have for the most part been resolved duringthe last few years, and it is likely that China's new procurement staff will be much better prepared.In the recent Sichuan Gas Project (Loan 3716-CHA), the Government has organized a CoordinationCommittee to ensure that procurement processing remains on track. The detailed operation of thiscommittee and its impact on the interface among the various agencies is yet to be determined, and itseffectiveness is yet to be tested, but its establishment does indicate that the problem has been recognizedat the highest levels.

4.14 Negotiation of Contracts. Substantial delays also took place after the winning contractor hadbeen agreed upon. Negotiations on the final terms and conditions of contracts often took up to 10months, an exceptionally long time by Bank standards. For consultant study contracts, somenegotiations took up to 18 months. In addition, implementation process was also far from smooth.Studies were often extended or delayed due to the borrower's expectations about what the final resultsshould be. These delays were often caused by differences in opinion between the project entity and thecontractors on the appropriate scope of the work to be performed and, sometimes on the insistence ofthe project entities to expend the coverage of certain aspects of the scope.

4.15 Writing the Bidding Documents: There were, in addition, other significant causes for delayedproject implementation that could be avoided in the future. The most critical of these was the initialimplementation delay, which was in writing the technical specifications for the bidding documents.. Thisbid preparation process took nine to twelve months instead of the three that had originally beenscheduled. The Bank could have greatly reduced this delay. First, it initiated this critical path activityrather late in the project preparation cycle: only shortly before the project was taken to the Board.Second, it apparently chose a firm that it had not worked with before and failed to enforce the agreedtime schedule. Having started so late, the Bank needed to maintain a close control and supervision tominimize further delays.

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4.16 Recommendation: Training programs for Bank procurement and loan disbursement practicesshould be a required part of any project with a new borrower or new executing agency. These programsare particularly important when the country itself has only recently joined the Bank Group, isundergoing a transformation to a more open economy and is, as yet, still unfamiliar with intemationalbidding and Bank procedures. Where inter-agency coordination is necessary, a procurement seminarshould be given exclusively for all the staff who will have to work together on the new project. In thisway the seminar could initiate the process of teamwork that is needed for efficient projectimplementation.

4.17 Recommendation: The Bank may need to consider intervening in the contract negotiationswhen they extend beyond what would appear to be normal and appropriate, or when a pattem ofextended negotiations begins to develop. In such cases the Bank could request a participatory role asa neutral facilitator, to keep the negotiations in line with the scope of the original bidding documents.Such intervention could be particularly important when the recommendations of the consultant studyare considered critical for proper implementation of other project elements.

4.18 Recommendation: If a project is expected to be implemented quickly, it may be necessary tohire a consultant company to prepare bidding packages during the Appraisal Mission, so that the initialbidding documents could be ready for discussion at, or before negotiations.

The Reservoir Study

4.19 The Reservoir Study was supposed to be the central element of an optimal development planfor the South Weiyuan oilfield. However it took four times as long to implement as expected, andnever produced the results expected by ZPEB. At appraisal (September 1982) it was agreed that itwould be initiated in April 1983, and would be completed within nine months, that is by the end of1983. Such timing would have been highly optimistic under any conditions. In China, with its complexprocurement procedures, and its lack of experience in working with foreign consultant firms, it wastotally unrealistic.

4.20 The study was actually started in May, 1984, a year behind schedule. Part of the delay was dueto a six-month long negotiations with the winning bidder during which the terms of reference wererevised and refined. The study got off to a bad start when ZPEB realized that the consultant'sexperience was primarily with marine sedimentary basins, rather than continental sedimentary basins,such as those found in Zhongyuan. The study was then dragged out for four years, during which timeZPEB was able to get the consultant to substantially deepen its investigation. Only about 80% of theagreed tasks had been completed when the consultant company declared bankruptcy and stoppedoperating. However, by this time study results were of only an academic interest, since almost all ofthe decisions on how to develop the field had already been made and the wells drilled and completed.Furthermore, ZPEB would have been unable to expand on the reservoir analysis for the next phase ofsecondary enhanced recovery, because the contract had not included the modeling software needed toextend th