Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 3949-CHA

STAFF APPRAISAL REPORT

CHINA

DAQING OILFIELD GAOTAIZI RESERVOIR DEVELOPMENT PROJECT

December 29, 1982

Energy DepartmentPetroleum Projects, Division I

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(February 1982)

1 Yuan US$0.551.8 Yuan US$1.00

FISCAL YEAR

January 1 to December 31

WEIGHTS AND MFASURES

1 British thermal unit (Btu) = 0.252 kilocalories (keal)1 barrel (bbl) = 0.159 cubic meters (cu m)1 kilogram of coal equivalent (kgce) = 0.64 kilogram of oil equivalent1 kilometer (km) 0.621 miles (mi)1 kilowatt (kw) 1,000 watts (w)1 kWh = Kilowatt hour1 megawatt (MW) = 1,000 kilowatts (kw)1 cubic foot (CF) 0.0283 cubic meter (cu m)

ABBREVIATIONS AND ACRONYMS

°API = American Petroleum Institute degrees (API gravity)CNOOC = China National Offshore Oil CorporationCONGEDC = China Oil and Natural Gas Exploration and Development

CorporationDPAB = Daqing Petroleum Administrative BureauEOR = Enhanced Oil RecoveryGOC = Government of ChinaLPG = Liquefied Petroleum GasMCF = Thousand cubic feetMOF = Ministry of FinanceMOG = Ministry of GeologyMOPI = Ministry of Petroleum IndustryPCN1 = Production Company No.1PCPRC = Petroleum Corporation of the People's Republic of ChinaPVT = Pressure - Volume - TemperatureRDI = Research and Design Institute (DPAB)SPC = State Planning Commission

FOR OFFICIAL USE ONLY

CHINA

DAQING OILFIELD GAOTAIZI RESERVOIR DEVELOPMENT PROJECT

Table of Contents

Page No.

I. ENERGY SECTOR ............................. 1.........

Introduction ............................. 1..... Energy Balance .................... . 2Resource Endowment . 4

Coal .................... 4Power ............................ 4Oil and Gas .......... 5.... .... 5Oil Shale ............... 5Geothermal . 6Non-Commercial Energy ... 6

Distribution of Energy Resources 6Scale of Development. 7Efficiency of Energy Use ...................... 7

II. OIL AND GAS SECTOR.............................. 8

Background ............... 8Petroleum Geology .9Institutions. 9

Exploration Policy .10Onshore .10Offshore ................................. 10

Hydrocarbon Bearing Structures ................ 11Onshore .11Offshore .13

Current and Anticipated Level of OilProduction ............. 13

Quality of Crude Oil .15Transportation .. 15Refineries .. 15Consumption Patter .. 16Natural Gas ................................... 17Prices . .18Planning and Investment .20Role of the Bank .. 21

III. BENEFICIARY ...................................... 23

Background .. 23Functions .23

This report has been prepared by Messrs. V. Nayyar, J. Davis, A. El Mekkawy,M. Wormser and Ms. S. Shum of the Energy Department, with the support ofMessrs. D.G. Fallen-Bailey, H. Dunlap, B. Whalen and R. Monicard, who acted asconsultants for the mission.

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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Capital Structure .. 23Organization and Management . . 23Project Implementation .. 25(a) Production Company ....................... 25(b) Drilling Company and Other Auxilliary....

Services Companies ..................... 25(c) Project Unit ............................. 26Accounting .. 26Costing . . 27Financial Reporting .. 27Internal Control System .. 27External Audit .. 28Incentive System .. 29Insurance .. 29

IV. THE PROJECT ....................................... 29

Background .................................... 29Geology ....................................... 29Quality of Oil ................................ 30Production Potential and Project Design ....... 30Project Objectives ............................ 32Project Description ........................... 32Project Implementation ........................ 34Drilling and Production Practices ............. 35Reservoir Study ............................... 35Enhanced Oil Recovery (EOR) ................... 35Review of Process Flow Design and Optimization

of Surface Facilities ...................... 36Drilling and Completion Practices ............. 36Implementation Schedule ....................... 37Project Costs ................................. 37Project Financing ............................. 38Allocation and Disbursement of Bank Loan ...... 39Procurement ................................... 39Training ...................................... 40Laboratories .................................. 41Computer Facilities ........................... 41Project Risks ................................. 41Ecology and Safety ............................ 42Reporting Requirements ........................ 42

V. FINANCES ......................................... 42

Introduction .................................. 42Past Finances ................................. 44Capitalization.45Investment and Field Maintenance Program

FY81 - 85 .................................. 45

Pricing ....................................... 46G Reservoir Development (The Project) ......... 48Performance Measurement ....................... 49

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VI. ECONOMIC ANALYSIS ................................. 50

Background .................................... 50Project Costs ................................. 50Project Benefits .............................. 50Economic Rate of Return and Net Present Value

of Project Benefits ....................... 51Sensitivity Analysis .......................... 51Other Benefits ................................ 51

VII. RECOMMENDATIONS .................................. 52

ANNEXES

2.01 Organization Chart - Ministry of Petroleum Industry

3.01 Organization Chart - Daqing Petroleum Administrative Bureau3.02 Organization Chart - Production Company No. 13.03 Organization Chart - Drilling Company No. 2

4.01 Gaotaizi Reservoir Performance and Expected Production Profile4.02 Detailed Project Cost4.03 Implementation Schedule4.04 Allocation of Bank Loan4.05 Disbursement Schedule of Bank Loan4.06 Notes on Training for 'Workers and Professionals4.07 Design of Computer Network

5.01 DPAB Income Statement (1978 - 80)5.02 DPAB Balance Sheet (1978 - 80)5.03 DPAB Projected Income Statement (1981 - 85)5.04 DPAB Projected Balance Sheet (1981 - 85)5.05 DPAB Projected Sources and Uses of Funds (1981 - 85)5.06 Flow of Funds Between DPAB and GOC (1978 - 85)5.07 DPAB Unit Cost of Production (1978 - 85)

6.01 Economic Analysis

7.01 Related Documents and Data Available in the Project File

MAPS

IBRD 16436RIBRD 16437

I. ENERGY SECTOR!,

Introduction

1.01 China is well endowed in primary energy. It is the fourth largestproducer of commercial energy after the United States, the Soviet Union andSaudi Arabia. Output of commercial energy is one-fifth of US and one-third ofUSSR. Coal and lignite reserves are estimated at over 600 billion tons. Atthe present rate of consumption these reserves are adequate for more than athousand years. Annual hydro potential is estimated at 1,900 billion kWh,against the present hydro generation of 58 billion kWh and overall powergeneration potential of 300 billion kWh. Official estimates of oil and gasreserves are not available. Unofficial estimates, however, place therecoverable reserves of oil at 1.8-2.5 billion tons, and of natural gas, bothassociated and non-associated, at about 130 billion cubic meters (equivalentto over 110 million tons of oil). From the review of the sedimentary basins,the ultimate recoverable reserves of oil are estimated to be in the range of12 to 20 billion tons. In addition, the reserves of oil shales are reportedto be of the order of about 400 billion tons. For a number of reasons,including logistics, substantial investment requirements and long gestationperiod needed for developing coal and hydro potential, the relative share ofcoal and hydro power in the overall energy balance is not anticipated toincrease significantly over the next ten years.

1.02 China's achievement in developing its energy resources, over the lastthree decades has been impressive. Production of coal has increased fromlittle over 60 million tons in 1952 to 620 million tons in 1981. During thesame period, power generating capacity increased from a little less than 2000MW to 67,000 MW. Oil production increased from about 0.1 million tons in 1950to 106 million tons by 1979. Output of oil fell marginally to about 101million tons in 1981. This rapid pace of development has pushed China intothe rank of the third largest consumer of commercial energy in the world,behind USA and the Soviet Union, but ahead of Japan.

1.03 China's global pre-eminence as a producer and consumer of commercialenergy notwithstanding, its consumption pattern is more analogous to adeveloping country where a large proportion of the population continues torely upon non-commercial sources (plant residue and animal power) for meetingits energy requirements. Consumption per capita is about 650 kilograms ofcoal equivalent (kgce), which is slightly above the average for developing

1/ For a more detailed discussion please see Bank's report No. 3391-CHA -China: Socialist Economic Development - Annex E: The Energy Sector.

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countries (620 kgce). In fact, China's energy sector is a curious amalgam ofthe traditional and the modern and of advanced technologies and inefficientpractices. The future prospects remain uncertain, and while the probabilityfor retaining self-sufficiency in energy remains high throughout the eighties,it is doubtful if China would be able to sustain the rate of growth itachieved over the last two decades. Major oilfields have peaked and enteredinto a declining phase. No new discoveries have been made in a magnitude tooffset this decline. Rapid expansion of coal industry faces intractableproblems in terms of investment, location and transportation. Remoteness ofmajor hydro potential sites from the centers of consumption and the longgestation period, precludes hydropower share from increasing significantlybeyond its present level within the first half of the 1980's.

Energy Balance

1.04 The table below estimates the commercial energy balance for 1980,1981 and 1985.

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Energy Balance(Million Tons of Oil Equivalent)

Production 1980 % 1981 X 1985 %

Crude oil 105.9 24 101 24 95.0 20Natural Gas 12.3 3 10.5 2 9.5 2Coal 303.8 68 303.8 69 342.9 72Hydroelectricity 20.9 5 23.5 5 27.0 6

Total Availability 442.9 100 438.8 100 474.4 100

Consumption

1. Petroleum products 81.0 19 75.0 18 86.0 18Industry & commerce 35.5 8 32.9 8 37.1 8Power 16.5 4 15.3 4 12.1 2Transport 14.0 3 13.0 3 18.9 4Agriculture & construction 15.0 4 13.8 3 17.9 4

2. Natural gas 12.3 3 10.5 2 9.5 2Industry & Commerce:

Feed stock 4.9 1 4.2 1 3.8 0.7Fuel 5.9 1.5 5.0 1.2 4.6 1

Power 1.5 0.5 1.3 0.3 1.1 0.3

3. Coal 303.3 a/ 71 298.4 72 333.1 72Industry & commerce 182.0 43 179.0 43 185.6 40Power 57.3 13 56.4 14 74.0 16Transport 12.0 3 11.8 3 13.7 3Domestic 52.0 12 51.2 12 60.8 12.7Interfuel substitution

outside power - - - 1.5 0.3

4. Hydroelectricity 20.9 5 23.5 6 27.0 6

5. Refinery losses 7.0 2 7.0 2 6 2

Total domestic consumption 424.5 100 414.9 100 461.6 100

Exports

Crude oil 13.3 64 13.8 57 3.0 23Petroleum products 4.6 22 5.2 21 - -Coal 3.0 14 5.4 22 9.8 77

Total Exports 20.9 100 24.4 100 12.8 100

a/ Includes stock change of 5 million tons of coal or 2.5 million tons of oilequivalent.

Source: China: Socialist Economic Development - Annex E: The Energy Sectorand mission estimate.

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Resource Endowment

1.05 The major existing and potential sources of primary energy areindicated below:

(a) Coal

1.06 Coal is China's traditional source of energy and at present caters tonearly 70% of its demand for commercial energy. The output of raw coal in1981 was about 620 million tons, a level surpassed only by USA and IJSSR. Thecoal and lignite reserves are concentrated largely in the north and northeast,and represent about 70% of the total recoverable reserves in China (600billion tons). In terms of production also, the north and northeast accountfor 70% of the total national output and the south, with production level of15%, remains coal deficient. About 75% of coal production comes from largemines with more than 0.6 million tons annual capacity. The small mines (1000-100,000 tons annual capacity), over 20,000 in number, are rudimentaryunderground operations and the productivity is extremely poor. The output ofthe small mines goes essentially for meeting local commercial and domesticneeds. While there are some modern collieries in China, most of the mines areonly partly mechanized. Future plans call for increased mechanization in bothold and new mines, and for domestic manufacture of underground miningequipment. The Government expects the output to reach 700 million tons by1985. However, in increasing coal output, transport, essentially railroadcapacity, appears to be a major constraint.

(b) Power

1.07 China increased its generating capacity from little less than 2000 MWin 1952 to over 67,000 MW by 1981 - an average growth rate of about 14% perannum. Of this, 70% of the generating capacity is thermal (46,200 MW) and 30%is hydro (21,000 MW). In 1980, 309 billion kWh of power was generated, ofwhich about 80% was thermal and the balance 20% hydro. China's hydro powerpotential is among the largest in the world, and is estimated at 1900 billionkWh per year against the present hydro generation of about 60 billion kWh. TheChAng Jiang (Yangtze River), which flows through the southwestern portion ofChina and eastern Xizang (Tibet), holds the largest hydro potential. Onaccount of the terrain through which it flows, only limited efforts have beenmade to develop this potential. Major hydropower development has, however,taken place on the Huang He (Yellow River) and the Han Shiu (Han River) whichflow through northeastern part of China. Liujiaxia is the largest hydropowerstation in China and is constructed in Gansu on the Huang He. It has adesigned capacity of 1,225 MW and is annually capable of delivering about 5.7billion kWh. Danjiangkou is the second largest power station in China, islocated on Han Shiu and has a generating capacity of 900 MW. This hydrostation meets the power requirements of the province of Hubei. Presently,China has about eleven hydroelectric stations with a capacity of 290 MW orgreater. The other Chinese rivers which have major hydroelectric systems arethe Songhuajiang (590 MW), the Dadu River (508 MW), the Fuchun River andtributaries (1330 MW) and the Yalu River (1100 MW).

1.08 Over the last decade, the mini hydrostations got a tremendous impetusand grew from about 15,000 to about 90,000 in number. Typically, thesestations are about 50 kW in generating capacity, and are designed to meet theneeds of the rural areas. Besides providing power to the local communes,

reservoirs built for this purpose meet irrigation requirements, prevent floodsand are being used for pisciculture. The potential is indeed immense, and itcan be harnessed with local materials and the construction period is short.However, seasonality appears to be a major constraint.

(c) Oil and Gas

1.09 Growth in the hydrocarbon sector, over the last two decades, has beenequally remarkable. While oil was discovered in China in 1897, annual oilproduction up to 1950 was no more than 120,000 tons of which about 50,000 tonswas from oil shale. During the fifties, exploratory effort was confined tonorthwest China which resulted in small discoveries. However, from 1957,exploration was undertaken in the northeast and northern China, leading to thediscovery of the 'super giant' oilfield in Daqing in 1959. This was followedby discoveries in Shengli and Dagang in 1964. In 1965 petroleum productionreached 11.3 million tons and with that China became self-sufficient. Duringthe sixties, increase in oil production was relatively moderate; the majorspurt came in the seventies with production increasing from 30 million tons in1970 to 106 million tons in 1979. This increase came largely from thedevelopment of the Daqing oilfield, and to a lesser extent, from thedevelopment of the Shengli and Renqiu oilfields.

1.10 Official estimates of oil and gas reserves are not available. Themagnitude of China's proven and probable reserves is the subject ofconsiderable speculation and study outside the country. Varying estimatesrelating to the proven recoverable reserves have been made by differentgeologists/bodies; the opinion, however, is now converging to a range whichvaries from 1.8 to 2.5 billion tons. Estimates regarding possible andprobable reserves, both offshore and onshore, are by nature somewhatspeculative. The current estimates range from 5-10 billion tons in theonshore region and 4-8 billion tons in the offshore area.

1.11 Currently, the major non-associated gas fields are located in theSichuan Province and the recoverable reserves are estimated at 70 billioncubic meters. In addition, there are some minor natural gas fields in thenorthwestern part of China. Over and above this, the recoverable reserves ofassociated gas are estimated at about 50 billion cubic meters. The cumulativerecoverable gas reserves are thus about 130 billion cubic meters, equivalentto over 110 million tons of oil. There is, however, a view that gas reserveshave not been adequately explored and the presently known recoverable reservesare a mere fraction of the full potential. According to some estimates, theultimate recoverable reserves of natural gas, both offshore and onshore, couldbe as high as 3,000 billion cubic meters.

(d) Oil Shale

1.12 Reserves of oil shale in China are reported unofficially to be of theorder of 400 billion tons and may be much larger, since geological environmentis favorable for their formation in many of the sedimentary basins. Depositsof 100 billion tons or more, containing 5-10 billion tons of oil, are reportedin Heilongjiang and Hebei. The grade of most of oil shales is fairly low(less than 10%), but a few deposits have 10-20% of oil by weight. Before1958, oil shale accounted for almost half of Chinese oil production, but theproportion declined rapidly as normal crude oil production increased after thediscovery of the Daqing oilfield. Currently, from the Liaoning and Guangdong

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mines, about 300,000 tons of shale oil is being produced.

(e) Geothermal

1.13 China's geological conditions are such as to give rise to abundantgeothermal phenomena, especially in the Tibetan Plateau. Most occurrencesseem to be relatively low temperature ground water suitable for space heating;high temperature manifestation suitable for power generation seems to be morefrequent in the mountainous southwestern part of the country, such as YunnanProvince and Xizang Autonomous Region (Tibet). The Ministry of Geology, whichhas the responsibility for developing geothermal resources, has identified anddeveloped two projects. The first is a geothermal power station in theYangbajian geothermal field of Xizang, some 50 km from Lhasa and the other isan urban heating system developed in the southeastern part of Beijing.Geothermal energy has not been developed to a significant extent in China.Furthermore, its role is likely to be limited to urban heating systems in thecolder regions of the country and possibly to power generation in Xizang.

(f) Non-commercial Energy

1.14 Although no data base exists for quantifying the extent of non-commercial energy used in China, it is apparent that this form of energyconstitutes a significant proportion of the total energy used, especially inthe rural areas. Fuel wood from loppings and grass, animal and crop residue,and especially rice straw, are the principal sources of non-commercialenergy. Unofficial estimate places the energy extracted from these sources at250 million tons of coal equivalent or about one-third of the total energyused. If this estimate is correct, then the traditional fuels play a smallerrole in China than in most other countries with similar per capita levels.This is partially explained by a high population density and low availabilityof forest resources.

1.15 For maximizing the benefits from non-commercial sources of energy,China has pioneered and is now the leader in producing biogas. Biogas, whichcontains methane up to 65%, is produced by the fermentation of animal andhuman waste, vegetation, household garbage and waste water. Originating inthe Province of Sichuan, biogas digesters are now all over China with theexception of the colder reiions of the country, and currently exceed 6 millionin number. A typical 10 m digester, costs about 50 Yuans (US$30), and canmeet the composite energy needs of a family of five. In addition to theecological benefits, through lower deforestation and the saving of fossilfuels, biogas digesters produce organic fertilizer, an essential ingredientfor Chinese agriculture.

Distribution of Energy Resources

1.16 China's energy resources are not evenly distributed. The northeastand the north, with nearly 30% of China's population and more than 45% of thegross industrial output, have as much as 75% of the known commercial energy interms of coal and oil. These reserves currently account for the bulk of thecountry's production and are being extracted at a relatively fast pace. Theeast, with one-fifth of the total population and 30% of the industrial output,is almost devoid of any energy resource. The central south and southwestChina, except for hydropower potential, is equally bereft of other forms ofenergy. It is the northwest China, with possibly half of China's probable

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reserves of coal and oil,-and with major hydro potential in Xizang, whichwould need to be developed for meeting China's growing energy needs. Some ofthese areas, however, have a hostile environment, are inaccessible and verysparsely populated and, therefore, developing energy resources here wouldneither be cheap nor quick. It is for this reason that China is increasinglyconsidering its oil potential in the offshore area, especially in thesoutheastern continental shelf.

Scale of Development

1.17 One of the basic tenets of Chinese developmental philosophy has beengoing small on a big scale. This guiding principle has had a significantimpact on its energy policy and manifested itself in a large number of smallcoal mines, about 90,000 mini hydropower plants, and innumerable biogasunits. True, the productivity of the small coal mines is low and the workingenvironment is hazardous, and the cost of power generation in mini hydroplants is generally higher than in major hydropower stations. Yet, theseunits rely on local initiatives, skills, materials and capital, and have beenbrought onstream with commenDPABle speed. Most of the small coal mines havebeen developed in the energy deficient southern China and now provide the muchneeded fuel for local industries and households. Similarly mini hydrostations have a significant impact on the local economy by providing floodcontrol, irrigation, and power, without creating a draft on the major powerstations and on the under-developed transmission system. These stations havemade rural electrification possible on an extensive scale.

1.18 However, this policy has not been an unqualified success. Itsindiscriminate application to all facets of industrial activity spawned alarge number of small scale refineries, fertilizer units, cement, and iron andsteel platts. This led to dissipation of resources where economies of scalewere given up in deference to a developmental philosophy. 'Teakettle' refine-ries are inefficient and make product standardization impossible. Backyardfertilizer plants for synthesis of ammonia, besides requiring investment perunit of nutrient output which is two to three times higher than modern plants,produce product which is unstable and relatively ineffective in use. Smallscale iron and steel works are equally inefficient in terms of capital use andthe quality of product. This is not to suggest that this policy should beabandoned; it is merely to argue for a more rigorous economic scrutiny.

Efficiency of Energy Use

1.19 From the limited data available, it appears that China's level ofcommercial energy consumption is very high in relation to its economicactivity. Although global comparisons of commercial energy consumption perunit of GDP show China with an energy intensity level more than double that ofmost other developing countries and industrialized market economies, this is avery crude index of energy efficiency, and is subject to considerablevariation due to differences in economic structure (China has a relativelylarger heavy industrial sector than many other countries) and problemsassociated with the valuation of output. Nevertheless, micro-level energyintensity comparisons on a physical basis, particularly in industry, indicatesubstantial potential for improvement in industrial energy efficiency inChina. For example, in the steel industry, China's largest industrial energyconsumer (12% of total commercial energy), energy consumption per ton of crudesteel, even in large integrated plants, is approximately double the level

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achieved in best international practice, and energy consumption per ton in thesmall and medium plants is about 25% higher than in the larger plants. In thenitrogenous fertilizer industry, average energy consumption per ton of ammoniais roughly double that of best international practice, due partly to theoutmoded technology used in these smaller plants, and to different rawmaterials. The smaller scale plants, which produce over half the ammonia,have about one-half the energy efficiency of the newer larger plants inChina. The problem of small inefficient plants is also true in the brickindustry. Smaller brick plants, which produce 2/3 of the country's bricks,consume 50% more energy per ton of bricks than the larger plants.

1.20 The problem of energy efficiency in China is, therefore, due not onlyto certain managerial/operational inefficiencies, which might be corrected inthe relatively short term with little or no investment, but is also related tothe use of older-fashioned technology, inadequate facilities to capture wasteheat, the scale of industrial plants, and the raw materials used. Many ofthese problems will take longer to solve, and require substantial capitalinvestment and some industrial restructuring. The Government is well aware ofand highly concerned about these problems, and is promulgating a number ofpolicy measures to address them, while according energy conservation equalpriority with increasing energy production. These measures include plans toestablish a number of energy conservation technical assistance centers toassist industrial enterprises in evaluating and improving their energyefficiency, enterprise-level quota systems with accompanying bonus and pricingsystems for energy conservatin below or above quota, industrial restructuring(including decreased relative emphasis on heavy industry), and increasedtaxation on petroleum fuels to encourage both conservation and fuelsubstitution.

II. OIL AND GAS SECTOR

Background

2.01 China is perhaps the oldest user of hydrocarbons; the Zulujing fieldwas developed over 2000 years ago, producing gas through bamboo pipes and oilfrom dug pits. In the modern times, the first oilfield was discovered in 1897at Dushanzi in the Junggar basin, followed by another discovery in 1907 atYanchang in the Shaanxi Province. Over the next forty years, exploratoryefforts were minimal, relied largely on the initiative of the privatecompanies and the total number of wells drilled was less than 170. Thisdrilling activity led to the discovery of three oil and two gas fields. Thesize of the discoveries and the production level was modest and an importantconstituent of the output was shale oil. Production averaged about 70,000tons per year and reached 120,000 tons by 1950. Of this, shale oil accountedfor 50,000 tons.

2.02 It was only after 1950 that a concerted effort was made to increaseoil production. The older oilfields (Jiuquan, Yanchang and Dushanzi) wereexpanded to increase oil production. Separately, exploratory effort wasstepped up in northwest China leading to the discovery of the Karamay oilfieldin the Xinjiang Autonomous Region. The scale and the size of the discoveries

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were small, and China had to rely on imported oil to meet its requirements.As of 1957, the focus of exploration shifted to the north and northeast Chinaleading to the discovery of the super giant oilfield in the Songliao basin in1959. Called 'the great celebration', the Daqing oilfield, since itsdiscovery, has accounted for more than 50% of China's total oil production.

Petroleum Geology

2.03 The petroleum geology of China is unusual in that most of the knownpetroleum accumulations are found in the sedimentary rocks of lacustrinerather than marine origin, laid down in ancient lakes or inland seas whichoccupied depressions in the Chinese landmass. These sediments now underlielarge areas of the North China Plain and the Xinjiang Autonomous Region in thenorthwest. Oil and gas were formed in rocks of Mesozoic and earlier Tertiaryage and accumulated in sand beds intercolated with the shaly source rocks.The reservoirs are block faulted quite intensely and their origin tend to bethin and poorly sorted, but so numerous that the aggregate oil bearingthickness in the section is appreciable. Nine petroliferous basins have beenidentified onshore China; the Songliao and the North China Plain basins in thenorth and northeast China, Sichuan and Guangxi basins in southern China,Shaanxi and Qin-Chuan basins in central China and the Qaidam, Tarim andJunggar basins in the northwest China. Presently the Songliao and the NorthChina Plain basins are the most prolific producers of oil, accounting for morethan 90% of its production; but the basins in the remote and inhospitablenorthwest are estimated to contain the largest oil potential. Substantial oilaccumulations have been proved in China and an aggregate daily productionlevel of 2 million barrels places China among the largest oil producingcountries of the world.

Institutions

2.04 The Ministry of Petroleum Industry (MOPI) oversees all aspects of oiland natural gas activities which include policy making and overall planning,exploration, production, distribution, transportation, research/design andtraining. Created as a Bureau in the Ministry of Fuel Industry in October,1949, it became a full ministry in 1955 and oversaw the opening of the Daqingoilfield in 1959 and the various discoveries thereafter. In 1970 it wasmerged with the Ministry of Coal and the Ministry of Chemical Industry. In1978, the ministries were split and MOPI once again became an independententity. The organization chart of MOPI is in annex 2.01. The petroleumindustry in China has been in a state of continuous change; this has blurredthe lines of responsibility and created its own anomalies. The Ministry ofGeology (MOG), in addition to being in charge of petroleum related geologicalwork, separately and independently undertakes offshore exploration. Export ofoil and procurement of foreign technology and equipment relating to the oilindustry is the responsibility of several corporations under the charge of theMinistry of Foreign Economic Relations and Trade. Similarly, fragmentation ofresponsibility exists in refining; some refineries are managed by MOPI whileothers are managed by the Ministry of Chemical Industry. There is also aconsiderable overlap in technical training and research; its administrativeresponsibility is shared/divided betweeen MOPI, Ministry of Education and theChinese Academy of Sciences.

2.05 For securing foreign technology and undertaking external liason, thePetroleum Corporation of the People's Republic of China (PCPRC) was created in

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1977. The principal objective of PCPRC and its affiliate, the China Oil andNatural Gas Exploration and Development Corporation (CONGEDC), was to enterinto agreements with foreign oil companies, especially in regard to offshoregeophysical and seismic work. As of February 16, 1982, the China NationalOffshore Oil Corporation (CNOOC) was created. This Corporation will take overall the offshore functions and contractual rights and obligations of PCPRC andCONGEDC. CNOOC will be responsible for inviting and evaluating bids andentering into offshore petroleum agreements with foreign oil companies. Forimplementing petroleum contracts and contracts for the construction ofoffshore installation and facilities, CNOOC will set up regional subsidiarycorporations, namely, the Bohai Bay Oil Company, the South Yellow Sea OilCompany, the Eastern South China Sea Oil Company and the Western South ChinaSea Oil Company. In addition, CNOOC is considering establishing otherspecialized companies.

Exploration Policy

(a) Onshore

2.06 In exploration, as in other sectors, China, till the late seventies,followed the policy of total self reliance and met with remarkable success.Exploration is done by about 300 seismic crews and 500 drilling rigs, whichannually drill 2000 to 3000 wells. The rate of discovery has, however, beendeclining (Renqiu was the last major discovery) and, faced with the prospectof falling oil production, China has modulated its exploration policy.Firstly, it proposes to undertake detailed seismic survey around existingoilfields. This will help identify peripheral sands which could partiallyoffset the anticipated decline. Secondly, it proposes to shift the focus ofexploration from north and northeast to Tarim, Qaidam, Junggar and Ordosbasins in the north and northwest. This shift will not be easy; all thesebasins are located in the remote northwestern China, are only tenuously linkedwith the rest of the country, have extremely hostile weather and difficultdrilling conditions. Pay zones are at considerable depths (5,000 to 9,000meters) and the formation pressure and temperature is high. Developing thisarea would therefore require a quantum jump both in investment andtechnology. Thirdly, and recognizing the above, China has secured, on alimited scale, assistance of foreign companies for undertaking seismic surveysand exploratory drilling in specially difficult areas. As these basins areestimated to hold about 50% of China's onshore recoverable reserves, GOCintends, over the next five years, to concentrate its exploratory efforts inthis area. Finally, China is seriously considering inviting foreign oilcompanies to participate in exploration and production, specially in thesedifficult areas.

(b) Offshore

2.07 Prior to 1979, China had on its own undertaken seismic work anddeveloped offshore structures in the Bohai area, and in doing so recognizedthe limitation of its offshore technology. Thereafter, in a major policychange, China sought the active cooperation of foreign oil companies inidentifying and developing its offshore structures. 48 foreign oil companies,from 12 countries, were invited to undertake geophysical and seismic work over420,000 square kilometers of China's offshore sedimentary basins. Thesesurveys identified six prospective basins, namely, the Bohai, the South YellowSea, the East China Sea, the Pearl River, the Southwest Hainan Islands, and

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the Tonkin Bay basins. More than 475 prospective oil structures have beenidentified in these basins. Present evidence indicates that the Zhujiang(Pearl River) estuary is the most prospective.

2.08 In order to enable the participation of foreign oil companies inexploring its offshore basins, GOC on January 30, 1982, promulgated"Regulations on the Exploitation of Offshore Petroleum Resources inCooperation with Foreign Enterprises." These regulations enable GOC to enterinto petroleum contract with foreign oil companies whereunder and in terms ofthe contract, these companies will bear the cost of all exploration investmentand accompanying risks. Once a commercial oil and/or gas field is discovered,both the foreign contractor and the CNOOC will invest jointly in itsdevelopment. Whereas initially the foreign contractor will be the operatorresponsible for developing and operating the field, under these regulations,CNOOC has the right to take over as the operator whenever it deems fit. Theforeign contracting party may recover its investment and expenses and receiveremunerations out of the petroleum produced according to the provisions of thepetroleum contract. Further, the foreign contracting parties are at libertyto deliver abroad their share of petroleum which is produced under thisagreement. The first round of bidding will take place in two phases. Thefirst phase relates to the northern part of the South Yellow Sea, and theZhujiang estuary in the South China Sea; the second phase concerns thesouthern part of the South Yellow Sea, the Beibu Wan basin in the South ChinaSea and the Yinggehai basin. The total area offered is about 150,000 squarekilometers. Bids for the first round were invited from foreign oil companieson February 16, 1982, and for the second phase in April 1982. Considerableinterest has been evinced by foreign oil companies to these offerings.

Hydrocarbon Bearing Structures

Onshore

2.09 The oil and gas bearing structures are spread out over the entireChina land mass and can be split up geographically into six regions. Oilproduction from each region along with the salient features of importantoilfields are discussed.

Northeast China

2.10 This region contains the prolific Sungliao basin with the oilfieldsof Daqing, Liaohe, Banshan and Fuyu. These oilfields account for about 60% ofChina's current oil production.

2.11 Daqing Oilfield. This oilfield is situated in the central portion ofthe Songliao basin, which is a large Mesozoic/Cenozoic inland sedimentarybasin covering approximately 25,000 square km. The Daqing oilfield measures140 km in the north-south direction and about 15-30 km in the east-westdirection. The oil reservoir lies at 700-1200 meters below the surface.Throughout its history, oil has been produced using water flood methods, thefield has now reached its maturity, oil production is declining while waterinjected in the reservoirs is increasing. Infill drilling, producing newreservoirs and enhanced oil recovery methods can be used to partially offsetthe decline.

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North China

2.12 This region contains Dagang oilfield in the Bohai basin and theRenqiu oilfield in the Baoding basin. In addition, recent discoveries havebeen made in Nei-Monggol, which is considered to be an extension of theSongliao basin.

2.13 Renqiu Oilfield. Located in Hebei Province, Renqiu is the firstdiscovery of a Precambrian reservoir in China. Rock characteristics make forirregular porosity and varying oil output. Over the last two years the outputfrom this field has declined sharply (30%), from 16 million tons to about 12million tons. However, new wells are being drilled at Renqiu; they tend to beprolific and may, therefore, offset the decline partially and add to theoutput.

2.14 Dagang Oilfield. This field is entirely Tertiary and consists ofabout 13 oil sands, totalling 37 meters of net pay. It is again a highlyfaulted and a fractured structure, making the development and the productionfrom the field complex and unpredictable. The pay zones are between 2000 -3000 meters in depth. The oil bearing strata appears and disappearsirregularly and the output at producing wells often fluctuates widely. Theoil is relatively light (340 API) and is reported to be sulphur free.

Eastern China

2.15 Shengli is the only major oilfield in this region. This field, whichcomprises about 40 small fields, totalling about 600 km , is scattered on bothsides of the Huang He near the Bohai basin. This oilfield was discovered in1962, production is from Miocene-Pliocene and Upper Tertiary strata, where awide variety of stratigraphic traps are situated. Oil sands are found insmall reservoirs, spread out in unpredictable patterns over a widely scatteredarea. Underground permeability and pressure conditions vary, warranting waterinjection in most of the cases. The quality of oil produced from this fieldis of poor quality, having a gravity of 220 API, with fuel oil and other heavyends accounting for 75% of the product yield. Recently another discovery hasbeen made in Chezhen in the Shandong province. Size of this discovery is tobe determined.

Central-South China

2.16 Major production from this region comes from two new discoveries,namely, the Nanyang field and the Zhong Yuan field, both located in theprovince of Henan. The Nanyang field is reported to be producing about onemillion tons of oil per annum. The Zhong Yuan oil basin lies about 500 kmsouth of Beijing in the basin of the Huang He. Exploration in this areastarted in 1977 and has led to the discovery of six small oilfields, namely,Wenliu, Fucheng, Wenmingzhai, Weicheng, Guoyunji and Qiaokou. Since itsdiscovery, 1900 line kilometers of seismic survey have been done and 280 wellshave been drilled. The current production level in these oilfields is 1.6million tons per annum.

Northwest China

2.17 This area was the scene of the country's first commercial discoveryat Dushanzi in 1897, an oilfield which still produces 0.5 million tons. In

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the same basin (Junggar), the Karamay oilfield was developed in the earlyfifties and continues to produce about 3.5 million tons per annum. The Lenghuoilfield in the Qinghai Province and the Yumen and Jiuquan oilfield in theGansu province are the other oilfields in this region. W4hile cumulatively thenorthwest region produces about 6 million tons of oil, it has basins which areconsidered to hold the largest petroleum potential. Of special significanceis the Tarim basin where three important discoveries are reported to have beenmade. Similarly, the Qaidam basin in northwestern Qinghai and the Ordos basinin the Shaanxi Province are considered extremely prospective. Taking intoaccount the potential of this area and the difficulties involved in drilling,MOPI has entered into service contracts with a number of foreign companies toundertake seismic work, data processing and exploratory drilling.

Southwest China

2.18 The Sichuan basin is the only hydrocarbon bearing structurediscovered in this region. Natural gas has been produced from gas fields inthis structure for over a hundred years. The oil production is nominal anddoes not exceed 0.1 million tons.

Offshore

2.19 Currently the Bohai gulf is the only source of offshore oil inChina. This gulf is relatively sheltered with a maximum water depth of 60meters; it has two producing oilfields; namely, Heise and Chengbei. Thesestructures were discovered in 1970 and 1973. Over 130 wells have been drilledin the Heise, but only six are currently producing. Eighteen wells areproducing in the Chengbei oilfield and cumulative oil production from theoffshore areas is less than half million tons per annum.

Current and Anticipated Level of Oil Production

2.20 The table below indicates the crude oil production by region andmajor fields.

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Crude Oil Production by Region and Major Fields/a

(Million Tons)

1970 1975 1977 1978 1979 1980 1981

Northeast 22.37 50.68 54.87 56.04 57.36 58.59 58.63

Daqing 21.18 46.26 50.31 50.38 50.75 51.50 51.75Liaohe & others 1.19 4.42 4.56 5.66 6.61 7.09 6.88

North 1.02 4.68 15.55 20.40 20.40 19.11 15.26

Renqiu - - 12.30 17.23 17.33 16.03 12.22Dagang 1.02 4.68 3.15 3.00 2.90 2.91 2.88Others - - 0.10 0.17 0.17 0.17 0.16

East 4.67 16.72 17.66 19.75 19.21 17.92 16.41

Shengli 4.67 16.72 17.52 19.47 18.88 17.59 16.11Others - - 0.14 0.28 0.33 0.33 0.30

Central-South 0.27 0.87 1.26 2.83 3.39 4.16 4.80

Northwest 2.29 4.02 4.21 4.94 5.69 6.06 5.99

Southwest 0.03 0.09 0.09 1.09 0.10 0.10 0.09

Total 30.65 77.06 93.64 105.05 106.15 105.94 101.18

2.21 Over the last one year oil output has fallen by about 3%. However,of greater significance is the fact that the major oilfields, which togetheraccount for 90% of China's oil production, have peaked; water cut (proportionof water to oil produced) is increasing exponentially; and consequentlydecline production has set in. With no major discovery to offset this fall,China would need to rely increasingly on infill drilling, enhanced oilrecovery (EOR) methods, exploring for and developing peripheral reservoirs andrapidly developing small discoveries. MOPI has initiated action in theseareas and efforts are under way for expanding oilfields such as Fuyu, Liaohe,Karamay, Zhong Yuan, Daqing (Gaotaizi reservoir), etc. In view of theseefforts, it is estimated that China will be able to temporarily stem thedecline and oil output up to 1985 may be in the range of 100-95 million tons.

2.22 The prognosis between 1985 and 1990 is less encouraging. By thistime, oil output from Daqing, Shengli, Renqiu and Dagang would be declining ata rapid pace. Furthermore, while prospects for offshore discoveries are rated

/a Source: Ministry of Petroleum Industry

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as very good, oil from the offshore areas is unlikely to augment China's oilproduction significantly prior to 1990. Similarly, even if major discoveriesare made in the northwest, intractable logistics make the field developmentand oil transportation an extremely complex and time consuming proposition.Thus, between 1985 and 1990 there is a distinct possibility of oil productionfalling to 90 million tons. Prospects beyond 1990 depend upon the successattending the current initiative to develop offshore structure with theassistance of foreign oil companies.

Quality of Crude Oil

2.23 Almost all Chinese crude oil has a high wax content and a high pourpoint, so that it is solid at ambient temperatures most of the year. Thesecharacteristics lead to severe problems in transportation and refining.

Transportation

2.24 Oil and petroleum products are transported by a variety of modes,including pipelines, waterways, railways and road transport. The first crudeoil pipeline was built in 1970. Two major pipelines link the Daqing oilfieldwith the Qinhuangdao refinery and the Dalian port. From this port the oil iseither exported or transported to other provinces. Another major pipelinenetwork links Dagang, Shengli, Renqiu and the Zhong Yuan oilfields with theNanjing city. Currently, the crude oil pipeline network extends over 70,000kilometers and the natural gas pipeline over 2,500 kilometers. Some 64% ofthe crude oil is transported by pipelines, 26% by waterways and the balance byrailways. Presently there are no product pipelines and the petroleum productsare moved largely by roads, water ways and railways. MOPI is, however,considering, plans to build multiproduct pipelines. All pipeline networks,outside the oil/gas fields, are built, operated and maintained by the PipelineAdministrative Bureau which is answerable to MOPI.

Refineries

2.25 The total refining capacity in China is 94 million tons, althoughthroughput in 1981 was limited to 73 million tons. Refining capacities varysignificantly - from 6 million tons per annum (MTPA) in Daqing and Beijing, to5 MTPA in Nanjing, Shanghai, Shengli, Maoming and to a host of teakettlerefineries of less than 0.5 MTPA capacity. The main refinery products arefuel oil (41%) diesel oil (27%), gasoline (16%) and kerosene (6%). Inaddition, they produce industrial solvents and chemical feedstocks. Therefineries located in the oilfields or those undertaking only the refining ofcrude oil are under the admininstrative control of MOPI. However, refinerieswhich also produce petrochemicals or undertake catalytic or hydro cracking areunder the Ministry of Chemical Industry. Overall refinery product yield isindicated below:

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Product Yield of Refineries(1000 Tons)

Product 1978 1979 1980 1981 X of total

Gasoline 9,913.9 10,698.6 10,790 11,010 16.0Kerosene 3,560.4 4,093.2 3,980 3,640 6.0Diesel oil 18,256.6 18,728.2 18,280 17,530 27.0Lubricating oil 1,806.2 1,914.8 1,970 1,500 3.0Fuel oil 28,142.9 28,161.2 31,420 28,180 41.0LPG - - 1,160 1,033 1.5

Other n.a n.a. n.a n.a 5.0

Consumption Pattern

2.26 Rising oil production led to an increased role of hydrocarbons in theChinese economy. Coal has been the traditional source of commercial energysupplying 90% of total energy as recently as 1965. The relative share of oiland natural gas increased from about 2% in 1965 to 22.5% in 1981, with coal(72.5%) and hydro (5%) providing the balance. The major consumer of oil isthe industry and commerce sector (43%) followed by transport (25%) and power(20%). Similarly, natural gas is used by industry to the extent of 88% andthe balance by power. Household consumption for illumination, heating andtransportation is minimal and accounts for less than 2%. An unusual featurein the consumption pattern is the direct use of crude, to the extent of 8million tons, as fuel oil. Non availability of refining facilities close tothe producing field, transportation constraints and poor quality of crude, inpart explain this wasteful practice.

2.27 While oil production during the last 16 years grew at about 15% perannum, consumption has kept pace. The table below indicates the overallproduction, consumption and export levels.

Oil Balances (1965-1985)(Million Tons)

AnnualActual Projected % Growth

1965 1970 1975 1977 1978 1979 1980 1981 1985 1965-1981

Production

Crude 11.3 30.65 77.06 93.64 105.05 106.15 105.94 101 95.0 14.7

Export - N.A. 12.28 11.46 13.94 17.15 18.29 19.09 3.0 N.A.DomesticConsumption 11.3 N.A. 64.78 82.18 91.11 89.0 87.65 81.91 92.0 13.2

2.28 Consumption has been growing at an annual rate of about 13%.However, faced with a situation of falling oil and gas production, efforts arebeing made to decelerate the growth; as a matter of fact consumption in 1981is reported to be about 82 million tons against the peak of 90 million tonsattained in 1978. However, it is moot if further reduction in consumption can

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be secured without adversely affecting the rate of growth. True there isconsiderable wastage of energy and the scope for replacing oil by coal issubstantial. However, bringing this about is not going to be easy or quick.Replacement of oil by coal would require substantial investment in terms oftransportation and extensive retrofitting. Similarly, once a production modehas been determined, the energy efficiency factor is locked in and majorimprovement in energy use cannot be secured without discarding theinvestment.

2.29 Forecasts relating to future demand of petroleum products are notavailable. Further, in the absence of detailed macroeconomic and sectoraldata, it is not possible to make any scientific forecast. However, working onthe growth rates assumed by the Bank's 1980 Econ omic Mission under thescenario of moderate growth and moderate saving,_ but applying them to thereduced consumption base for 1981, the demand for petroleum products in 1985is estimated to be about 92 million tons. Implications of such a scenario arefairly grave. China has so far been able to maintain the export level; infact stepped it up even in a situation of declining production. In 1980China's earnings from the export of oil are estimated at $4.75 billion andrepresented 26.5% of its total foreign exchange earnings. Consumption levelof 92 million tons would imply that as of 1985 oil would cease to be asignificant source of foreign exchange earnings.

Natural Gas

2.30 China produces gas in significant quantities; in 1981 production, ofgas (associated and non-associated) amounted to 12.5 billion cubic meters,equivalent to about 10.5 million tons of oil. Of this, gas produced inassociation with oil amounted to 6.2 billion cubic meters. The balance of 6.3billion cubic meters, is non-associated gas, which is produced essentially inthe Sichuan Province, although marginal quantities are also being produced inthe Qaidam basin in the northwest. The gas industry is not new to Sichuan asthe current gas fields were discovered and developed over hundred years ago.There are more than 200 gas bearing structures in the Sichuan Province and thecurrent production is around 5.6 billion cubic meters per annum. Weiyuan isthe largest gas field in Sichuan, producing about a billion cubic meters ayear, followed by Wulonghou, Shiyougou, Zigong, etc. The table belowindicates the production of gas by region.

l/ For greater details, please see Bank's report No. 3391-CHA - China:Socialist Economic Development - Annex E: The Energy Sector.

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Natural Gas Production/a

(Billion m3)

1977 1978 1979 1980 1981

Northeast 4.62 5.00 5.17 5.27 4.30

Daqing 3.00 3.20 3.31 3.39 2.80Others 1.62 1.80 1.86 1.88 1.50

North 0.78 0.82 0.93 0.80 0.70

Renqiu - - - - -

Dagang 0.78 0.82 0.93 0.80 0.70Others - - - - -

East 1.18 1.44 1.55 1.44 1.20

.Shengli 1.18 1.44 1.55 1.42 1.18Others - - - 0.02 0.02

Central-South 0.02 0.02 0.02 0.05 0.05

Northwest 0.26 0.30 0.33 0.38 0.45

Sichuan 5.26 6.15 6.51 6.33 5.80

Total 12.12 13.73 14.51 14.27 12.50

Associated 5.37 5.95 6.53 7.23 6.20Non-associated 6.75 7.78 7.98 7.04 6.30

2.31 Presently about 30% of the natural gas is used for fertilizers, about10% for petrochemicals and synthetic fibers and the balance of 60% is used asfuel, of which about 12% was used for thermal power plants. Non-associatedgas fields in the Sichuan Province, which have been producing for over 100years, have now entered a declining phase. Similarly, with the decline in oilproduction in the Daqing, Shengli and Dagang oilfields, production ofassociated gas would also decline. As a matter of fact, gas production in1981 in relation to 1980, registered a decline of about 13%, equivalent to 1.8million tons of oil. Fall in gas production would inevitably stimulate demandfor liquid hydrocarbons. It is, therefore, necessary that efforts areinitiated to explore for and develop non-associated gas prospects.

Prices

2.32 Prices of petroleum products, like other essential commodities inChina, are fixed by the National Price Administrative Bureau. This Bureau

/a Source: Ministry of Petroleum Industry.

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functions as an independent entity, and works under the supervision andguidance of the State Council. The oilfields sell crude oil to the refineriesat a well-head price of Y100 ($56) per ton, with the exception of northwestChina and Zhong Yuan oilfield (a new field discovered in 1977) which sellcrude at Y130 ($72) per ton. Refineries in turn sell petroleum products tothe Ministry of Commerce which is responsible for marketing the products.There is a price differential at every point, with the oilfields, therefineries, and the Ministry of Commerce, acting as profit centers for theState. The table below indicates the price of various petroleum products, ex-refinery and at the pump head.

Petroleum Product Prices

Ex-refinery prices Retail Price International/a Domestic PriceY/ton $/ton Y/ton $/ton price $/ton as % world

prices

Gasoline 590 327 800 444 340 130Kerosene 420 233 680 377 330 114Diesel 240 133 420 233 280 83Fuel oil 55 30 85L.b 47 160 29LPG 230 128 300 167 350 48Natural gas - - 2.9 1.6 4.0 40

(Y/MCF) ($/MCF) ($/MCF)/'c

2.33 Whereas products like motor gasoline, kerosene and diesel are pricednear the international level, the average price of the reconstituted barrelworks out to Y39 ($22), which is below the international price. This islargely because fuel oil is priced at a fraction of the international price(29%). Prices of petroleum products have now remained unchanged for the last20 years; while the Pricing Bureau is presently considering increasing theprice of crude oil sold to the refineries from Y100 and Y130 per ton to Y170per ton, it is not clear that this increase would be reflected in the endprices. The maximum it may, therefore, achieve is redistribute surplus fromthe refineries/Commerce Ministry to MOPI. The present pricing structure,especially that of fuel oil, runs counter to GOC'c avowed objective ofreplacing liquid hydrocarbon with coal, especially as boiler fuel. Nofinancial incentives now exist in China to switch from oil to coal, since fueloil in terms of calorific value, is cheaper than coal. However, thegovernment has sought during the past two years to encourage energyconservation and substitution of coal for oil through energy consumptiontargets for individual enterprises and other administrative means (see para.1.20). These appear to have had some success. The government estimates thatthese measures saved about 6 million tons of coal equivalent in 1981. In thepresent Chinese system, administrative measures probably still have more

/a FOB Singapore price on March 29, 1982./_ Assume transport cost, averaged at Y30/ton.Rc In terms of Btu fuel oil equivalent.

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influence on energy use and production than prices do. But it will beincreasingly important as decision-making is decentralized to ensure thatprice incentives reinforce rather than contradict administrative regulations.

Planning and Investment

2.34 The major economic instrument is the annual plan, which consists ofseveral parts, including a production plan, a material allocation plan, alabour plan, etc. The core of this document is a set of Interlocking materialbalance matrices, specifying sources (production, import, drawdown oninventory, etc.) and uses (intermediate input, investment, consumption,exports, etc.). The State Planning Commission (SPC) prepares the plan, withoverall responsibility for supervision resting primarily with the StateEconomic Commission. MOPI, like other line ministries, operates under theoverall supervision of these commisions. While SPC is the final arbiter forthe annual plan, its finalization is a result of a series of iterativeconsultations between SPC, MOPI and its constituent units, In the absence oflong term planning, there is an understandable preoccupation with the currentinstead of the future, a preference for short-run expedients over measureswhich aim at fostering productivity over the long run. This has at times ledto uneconomic extraction, rapidly rising production reserve ratio andrelatively inadequate investment in exploration or new technology.

2.35 The average investment in the oil and gas sector over the last fiveyears has been about Y2.8 billion ($1.55 billion). In the absence of a longterm plan, the future investment program for the sector is uncertain. Theannual plan for 1982 is being assumed to remain at the same level as 1981.Even during the past, investment has varied from year to year and theinvestment in 1978 was 50% higher than 1981 or what is programmed for thecurrent year. The major share of investment (50%) has gone into exploration,with oilfield development securing only 30%. The present investmentdevelopment works out to $0.6 per barrel - a figure which is not onlyindicative of relatively low cost levels obtaining in China, but moreimportantly, could be symptomatic of inadequate investment being made in theoil industry. So as to stem the anticipated decline in oil production, Chinawould need to step up investment substantially; for producing oil from peakingfields, development of peripheral sands and exploration in the northwesternpart, would require outlays which are quantitatively and qualitativelyhigher. Offshore development would create a further draft on resources, asunder the proposed participation agreement; even though the cost ofexploration is to be borne by the foreign oil companies, GOC would share thedevelopment costs to the extent of 51%. The table below indicates theinvestment made in exploration, development and refining during the last fiveyears.

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Investment for Exploration, Development and Refineries(Y Million)

Exploration Development Refinery TotalCrude Gas

1977 967 479 30 493 1,9691978 2,093 1,009 44 646 3,7921979 1,286 888 80 470 2,7241980 1,455 948 132 524 3,0591981 1,266 840 61 351 2,518

Average forperiod 1,413 833 69 497 2,812

% of total 50 30 2 18 100

Role of the Bank

2.36 China has so far been extremely successful in developing its oilresources. However, its major oilfields, which together account for 90% ofits oil production, have peaked. Inspite of relatively high outlays forexploration, Renqiu was the last major oil discovery. From available evidenceit is clear that China at least in the medium term faces the prospect ofdeclining oil production. There are also various constraints, includingtransportation bottlenecks, to the rate at which coal supply can beexpanded. The Government's energy strategy involves addressing the problem ofmoderating energy demand as well as expanding supply. Various measurs tocontrol demand are being implemented in the short term, including quotasystems, technical assistance to enterprises, and some industrialrestructuring (para. 1.20). Sector strategy over the longer term wouldrequire China taking step to increase its exploratory efforts, especially inthe offshore areas where private industry investment is being actively sought,and the northwest onshore areas, undertaking fuller development of coal andhydro potential and making structural adjustment in industry to improve theefficiency of energy use and permit the replacement of oil by coal. Coalmines would have to be modernized and transportation constraint resolved;while prospects of offshore oil discoveries are rated as high, oil insignificant amounts would be secured only after an extensive period ofexploration and development; similarly projects for developing hydro potentialhave a long lead time. In industry, which consumes over 70% of totalcommercial energy, major investments to improve and alter processes andmodernize older facilities will also take a few years to have substantialimpact, although significant savings should be achievable with little or noinvestment in the shorter term. Investment in many of these areas, however,is unlikely to yield significant results during the eighties. It is,therefore, critical that steps be taken to stem the anticipated decline in oilproduction and to obtain maximum impact from energy conservation. In thepetroleum sector, China would need to develop rapidly the small oilfieldswhich have already been discovered, undertake seismic surveys around existingoilfields in order to discover and identify peripheral sands, initiate aprogram for EOR, etc.

2.37 China is now facing problems typical to all oil producers, that is,

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being required to undertake exploration and production under increasinglydifficult and complex conditions. Achievement of the above mentioned mediumterm objectives would thus require, not only increased investment in the oiland gas sector, but also a major infusion of modern technology andequipment. Bank lending in the petroleum sector will have three basicobjectives: Firstly to develop known hydrocarbon bearing structures in orderto partially offset the anticipated decline; secondly in providing a vehiclefor the induction of modern technology to the Chinese oil industry; thirdlytraining and upgrading the skills of China's oil industry personnel in currentoilfield practices. On account of an extended period of technologicalisolation during the development of oil industry, China has not beensuccessful in discovering petroleum in complex geological environments nor hasit developed the technological capability to increase the recovery of oil fromexisting fields. COC is seeking the assistance of foreign oil companies inexploring and developing its offshore areas. This would, over a period oftime, also result in the transfer of offshore technology. In the onshorearea, especially in regard to the discovered and developed oilfields, the GOCexpects the Bank to act as a similar conduit for transferring technolgoy.During project preparation, substantial staff input was required foridentifying areas where technology needed to be upgraded. Much of theequipment used in the fields such as Daqing is obsolescent; there isrelatively limited familiarity in the techniques relating to deep drilling andfield practices such as drilling, cementing, casing, and formation loggingrequire an indepth evaluation. The attention of the Chinese authorities hasbeen drawn to the need to upgrade field practices; the current project wouldaddress itself directly to these issues by helping finance the import ofmodern equipment and technology. Further work will be needed in preparingterms of reference for technical studies, selection of consultants,supervision of studies, evaluation of findings, and finalizing andimplementing a plan of action based on these results, etc. GOC has soughtBank's assistance in this area which would be provided during theimplementation of the proposed project--and this is the primary rationale forBank's participation.

2.39 An important objective under the proposed loan is the training ofChinese technical staff and strengthening of their capabilities. Not onlywould engineers and technicians be trained in the use of new equipment and inmodern petroleum engineering practices, but a well equipped training centerwould be established together with operational laboratories to supplement theoperational work in the field. The loan will also assist in shaping thefuture investment program by helping finance important pre-investmentstudies. In the medium term the Bank's involvement in the sector would beaimed at developing rapidly the small oilfields which have already beendiscovered, undertaking seismic surveys in the vicinity of existing producingfields, and identifying and initiating enhanced oil recovery programs. Bankassistance would, therefore, be directed to further consolidate China'sproduction capabilities and subsequently assisting its exploration investmentprogram.

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III. BENEFICIARY

Background

3.01 The Daqing oilfield was discovered in 1959 and for developing thisfield, the Songliao Directorate was created in 1960. This Directorate wasestablished by the order of the State Council, and initially consisted ofexperienced personnel drawn from the Ministry of Petroleum Industry (MOPI) andother oilfields. By 1964, the magnitude of the discovery had become apparentand the city govetnment was created and vested with all functions relating tothe development of the oilfield, downstream activities like fertilizers andpetrochemicals, and the civil administration of the city includingagriculture, education and other social welfare activities. Thisadministration was responsible to MOPI for its oil related functions, and tothe provincial government for its remaining functions. In the seventies, themanagement of Daqing was placed under the Revolutionary Council with theprovincial government taking major decisions. However, as of 1978 functionsrelating to the oilfield and downstream industrial activities were separatedand placed under the Daqing Petroleum Administrative Bureau (DPAB), a stateowned enterprise independent from the municipal functions which continue to beperformed by the city government and the provincial government.

Functions

3.02 DPAB oversees all oilfield and downstream industrial activity. Itscurrent functions encompass:

-exploration and seismic work.

-oilfield development.

-refining of petroleum products.

-petrochemicals and fertilizers.

-research and design.

Capital Structure

3.03 The development of the Daqing oilfield has been financed exclusivelyby contributions from the Central Government and DPAB's internally generatedfunds. Government contribution is allocated yearly to DPAB according to theinvestment plan and is channelled to it through the Construction Bank, thedisbursing agency for the planning system. Total equity as of December 1980was $1.2 billion. DPAB has no outstanding long term debt.

Organization and Management

3.04 DPAB management vests in a president, who is assisted by a seniorvice-president (operations) and six vice-presidents in charge ofpetrochemicals, capital construction, drilling and exploration, oilproduction, administration, and scientific research respectively. ThePresident of DPAB is also the mayor of Daqing and in that capacity heads thecivil administration and oversees all other socioeconomic activities including

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health, housing, agriculture, education, etc. Earlier, DPAB was answerableboth to the provincial government and MOPI; as of 1980, MOPI is almost fullyresponsible for overseeing the performance of DPAB. The president of DPABreports to MOPI through a vice-minister who is exclusively in charge of allmatters relating to Daqing.

3.05 DPAB functions are essentially managerial, with specialized companiesbeing responsible for various oilfield activities. The entire field isdivided into seven regions, and a regional oil production company has theresponsibility for developing and producing oil from that area. The oilproduction company carries out drilling through one of the two drillingcompanies in Daqing. These drilling companies in turn secure specializedservices like logging, cementation, and other downhole services from DPAB'sspecialized companies, established specifically for this purpose. Surfaceconstruction is carried out by the Surface Construction Company and allmaterial is secured and provided to various companies by the Material SuppliesCompany. The responsibility for research, design and provision of scientificand engineering support is with the Research and Design Institute. TheOrganization Chart for DPAB is at Annex 3.01. The companies follow thestandard Chinese organizational pattern, namely, they are divided intobrigades and brigades in turn into teams. The brigade consists of 10 to 15specialists, who function as staff officers to the brigade leader. Thebrigade leader is responsible for the fulfillment of the stipulated targets bythe teams under its command. The brigade leader and its staff are usuallyprofessionals with managerial responsibilities, while skilled workers man theteams. A team typically consists of 50 - 100 persons, with the team leaderwho is an experienced skilled worker.

3.06 Production targets are annually established for Daqing by MOPI.These targets are derived from the annual planned targets for the entireeconomy. These targets, initially framed in broad outlines, are passed downto DPAB, which spells out the details, evaluates the feasibility and works outits financial implications. Consequently, through a series of iterations, theannual plan is agreed upon. Following a similar process, DPAB in turn evolvesa work program for various companies, their respective brigades and teams.Once this exercise has been completed, DPAB enjoys considerable operationalautonomy and is answerable to MOPI only for results. Its financial autonomyis, however, far more constrained; DPAB must secure inputs from designatedsources at predetermined prices; similarly it must sell its output tospecified agencies at prices which are set by the Government. Its investmentplan must conform to the national priorities and even within the framework ofthe approved plan, it must seek the clearance of the Central Government forany foreign exchange expenditure or material inputs designated as essential.

3.07 Daqing, for long, has been considered the technological capital ofChina, a model of industrial growth for the rest of the country to emulate.This has been for good and valid reasons. Without external assistance andwith outdated technology, Daqing was developed into one of the largestoilfields in the world and a major industrial complex. Management at alllevels is dedicated, competent, innovative and remarkably able in pursuing andachieving assigned tasks. Its personnel is hardworking, talented anddisciplined, which makes DPAB an extremely effective organization, capable ofcarrying out ambitious programs within the framework of severe constraints andlimitations. Its managers appeared perceptive about their technical problems,

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both in research and production. The major deficiencies arise on account ofthe oilfield having been developed in an environment of technologicalisolation, with methods adopted and decisions taken on the basis of extremelylimited information. As a result, mistakes and inefficient choices have attimes been made. The project, as designed, takes these limitations intoaccount. The major emphasis is on inducting new technology, refurbishingresearch facilities, modifying and improving field practices, and upgradingthe level of training. Given the organizational strength of DPAB, there islittle doubt that the proposed project will be implemented with competence andspeed. (See para. 4.09-4.10)

Project Implementation

(a) Production Company

3.08 Production Company No. 1 (PCNl) will be responsible for thedevelopment of the Gaotaizi (G) reservoir. This company operates the Sa'ertufield and is responsible for operations over an area of 160 squarekilometers. Its crude oil production for 1981 was about 10 million tons. Ithas a work force of about 9,770 workers, including 600 university and juniorcollege graduates. This company is headed by a director, who is assisted bysix vice-directors responsible for technical management, engineering, geology,capital construction, oil production and finance. The company operatesthrough oil production brigades (5), each of each oversees oil productionteams (85), which have the direct responsibility for operating and maintainingoil and water injection wells. The oil production brigades/teams aresupported by similarly organized brigades/teams which are responsible for wellservicing, maintenance and repairs, geological and technical services,transportation, etc. The organization chart of PCN1 is at annex 3.02. PCN1is a well-managed company. It has developed the Sa'ertu oilfields, currentlyoperates and maintains all the oil wells, water injection wells, and ancillaryproduction and services facilities.

(b) Drilling Company and Other Auxiliary Services Companies.

3.09 Drilling Company No. 2 will be responsible for drilling the oil andwater injection wells for the proposed project. The company's work force isabout 5,500, of which about 350 are university or junior college graduates.It is headed by a Director who is assisted by five deputy directors, each incharge of production, equipment, administration and finance, engineering andgeneral services. The actual drilling is carried out through two productionbrigades which are in turn subdivided into 22 drilling teams. Each drillingteam has 50-60 skilled workers, is headed by a team leader and operates inshifts, 24 hours a day. Production teams are assisted by similarlyconstituted units, namely, installation and moving unit (one brigade with nineteams), transporation unit (one brigade with seven teams) and equipment andsupply unit (one brigade with four teams). The Organization Chart of theDrilling Company No. 2 is at Annex 3.03. The company owns and operates 22rigs. In 1981 it drilled 474 oil and water injection wells. Judged againstpetroleum industry standards, this company operates with considerableefficiency; inspite of extremely difficult drilling conditions for four monthsin a year, each rig on an average logged operating hours of 4,900/per annum ofwhich drilling activity accounted for 2,940 hours. On an average each rigdrilled 21 wells per annum, involving a cumulative drilling of about 27,500meters.

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3.10 Auxiliary companies will provide specialized services to the DrillingCompany. The Drilling Service Company will log the wells, and be responsiblefor mud engineering and cementation. The Testing Company will carry outvarious oil tests and also perforating jobs. The Downhole Company will beresponsible for fracturing and other downhole services. PCNI will enter intoagreement with Drilling Company No. 2 for undertaking all work relating todevelopment drilling and the Drilling Company No. 2 will enter into similararrangement with auxiliary companies for providing various well services. Forsurface construction, separate agreement would be entered into between PCN1and the Surface Construction Company. Besides these four main servicecompanies, the services of about ten companies will be secured on an "asneeded" basis (communication, transporation, repairs, etc.).

(c) Project Unit

3.11 PCNI, Drilling Company No. 2 and auxiliary companies relating todrilling operation and maintenance of wells are capable of implementing theproject in a satisfactory manner. However, for coordinating and monitoringdevelopment program relating to the G reservoir, it would be desirable toestablish a special project team in PCN1. During negotiations DPAB agreed toestablish by March 31, 1983 such a team in PCNI, which would be headed by aDeputy-Director (see para. 4.12).

Accounting

3.12 DPAB follows the "Accounting System for State Run Enterprises"enacted by GOC in 1953 and subsequently revised in 1960 and 1981. While theaccounting arrangements are satisfactory in the context of the GOC financialsetup, there are fundamental differences between some of DPAB's practices andthe generally accepted accounting practices of commercially oriented petroleumenterprises. Special features of DPAB's financial and accounting practicesare:

(a) DPAB maintains two separate sets of accounts for its oilfieldactivities--one set for capital construction and the other forproduction. Since these two sets of accounts are not beingconsolidated, DPAB's balance sheet for production does not includeconstruction work-in-progress.

(b) DPAB reports all exploration costs under the capital constructionaccount. MOPI finances the approved costs for exploration. Tn theevent that exploratory wells are turned into production wells, thelatter are reported by DPAB in its balance sheet for production andare valued at the standard cost in production wells.

(c) MOPI allows DPAB to classify investment expenditure for oilfielduphold as operating expenses. DPAB's oilfield maintenance andrepairs are financed from overhaul fund allocations which are chargedas operating expenses; unused overhaul funds budgetted for thecurrent year can be carried forward to future years (para. 5.05). Inessence, while DPAB's oilfield uphold and overhaul provisions arereported as "cost" items on the income statement for the purpose ofcomputing net income, they are actually sources of internal fundsretained for oilfield maintenance, repairs and new investment.

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(d) While heavy emphasis is placed on the budget as a controlling tool,DPAB generally does not undertake financial planning beyond one year.

3.13 Given the uncertain range of recovery from the reservoirs and therelated costs of oil extraction, it would seem prudent for MOPI to extend thehorizon of financial planning in the industry as a tool for managementdecision-making. As a first step towards this direction, it is recommendedthat DPAB be used as a model, given its satisfactory record of short-runfinancial management. DPAB should reformulate its financial planning basedeither within the existing financial set-up or on the development of a newfinancial planning unit with the objective of producing financial plans forfive years for its oilfield investment and operations. As a part of thisprocess, DPAB would be expected to re-evaluate its costing techniques toensure they are responsive to the planning needs. The financial statementshased on the five year plans would be forwarded annually to the Bank. Inaddition, DPAB would be expected to consolidate its accounts for oilfieldcapital construction and production [see sub para. (a) above] in submittingits financial statements to the Bank in order to provide an overall view ofDPAB's financial performance and position.

Costing

3.14 Financial accountability at DPAB is organized under three levels ofcost centers--the bureau, the company and the brigade. DPAB's cost accountingsystem is comprehensive and satisfactory. For budgeting purposes, standardcosting is applied. Standard unit costs for DPAB are based on the prevailingprices except in the case of imported casing and tubing which are subsidizedby MOPI. Intercompany transactions are priced at standard quantities andcosts, while actual quantities are reported by the cost centers which incurthe expenges. Actual costs are calculated at the bureau level and thevariance between the actual and standard costs are allocated to the variouscost centers. Budgeted cost is a major yardstick against which theperformance of the cost centers is being measured, and achievement of costtargets is one of the basis for bonus reward (para. 3.19). Duringnegotiations DPAB agreed that separate project accounts would be maintainedfor the proposed project, whereby all the expenditures actually incurred forthe project are consolidated at the bureau level.

Financial Reporting

3.15 The financial reporting system at DPAB is satisfactory; reports onoperations and capital development are prepared at the brigade level,consolidated at the company level and then again at the bureau level. Theseinclude balance sheets and income statements, as well as budget varianceanalysis. All statements are prepared on a routine basis each month and arecumulated quarterly and yearly. The monthly reports are gathered by thebureau within three days after the end of each month and consolidated to betransmitted to MOF within 7 days after the end of the month. Annualstatements are furnished to the bureau within 25 days after the end of thefiscal year and from the bureau to MOPI within 55 days.

Internal Control System

3.16 Procedures used by DPAB demonstrate a high level of internal control;

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the segregation of functions is generally satisfactory; many checks andcontrols exist to prevent fraud and errors; physical inventories are regularlyundertaken (once a month in each warehouse); inventory of fixed assets iscarried out at least once a year. In addition, DPAB undertakes a regularreview of actual cost against standard/budgeted cost and a detailed varianceanalysis is performed.

3.17 While these procedures are generally adequate, DPAB does not have atpresent an independent, comprehensive and systematic centralized internalaudit function. Control of fixed assets is performed by the fixed assetssection in the finance department; physical inventory of material is carriedout by the materials company in its numerous warehouses. A financialdiscipline group, within the finance department at the bureau level, is incharge of checking that the financial/accounting practices at DPAB are in linewith the prescribed system of GOC. Such reviews are, however, achieved on anad-hoc basis, without a predetermined program and systematic auditprocedures. The financial discipline group is in part constrained by thelimited number of staff (presently only about ten in total) and, for largereviews, the group has to be supplemented by drawing upon the financial stafffrom other units. Under the existing system, there is no provision for anindependent assessment of the effectiveness of DPAB's internal controlsystem. The need for setting up a centralized and comprehensive internalaudit system was discussed both with DPAB and MOF and MOF will review theinternal audit process in the context of the overall audit policies of GOC(para. 3.18). This will be followed up during the supervision of the proposedproject.

External Audit

3.18 The GOC's present financial practice does not provide for externalauditing whose scope and depth are in conformity with internationally acceptedauditing standards. The responsibility of reviewing the accounts of stateenterprises in China is currently divided among the line ministry (MOPI), MOF,the Construction Bank and the People's Bank. A general review of the entity'sfinancial performance is undertaken on a yearly basis by MOPI; the scope ofthe review is mainly limited to the analysis of its achievement in relation toits targets. Review of specific accounts are performed by the ConstructionBank and the People's Bank. Some periodic checking of limited scope isperformed by the Ministry of Finance. In specific cases, an inquiry can beinstituted by the representatives of the National People's Congress. Thesecontrols, however, do not constitute an independent audit of DPAB's financialstatements.

3.19 The Ministry of Finance is currently addressing this issue and issetting up an independent audit group within the Ministry to review andcertify the financial statements of state enterprises. Regulations onauditing will be formulated and the independent audit group may, within twoyears, be transferred to the jurisdiction of the State Council. Technicalassistance will be provided for this purpose by several organizations,including UN and specific bilateral assistance. In the context of thisproject, during negotiations GOC and DPAB agreed to have the project accountand PCN1's accounts independently audited and transmitted to the Bank withinsix months after the end of each fiscal year.

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Incentive System

3.20 Bonus is distributed monthly when the monthly targets for production,cost, quality and safety, etc. are reached. Bonus amount varies with thenumber of targets reached by individual sub-units, the lowest level of whichis a team. The maximum annual bonus for overall DPAB is set by MOPI at 2.7months of DPAB's average worker salary. For purposes of bonus distribution,DPAB-s staff is divided into three categories: (i) production workers; (ii)service workers; and (iii) office staff. Workers directly involved withproduction receive the largest amount of bonus while the office staff are atthe lowest end of the bonus scale. However, much more than the monetaryincentives, it is the extensively disseminated work ethics, carefully nurtureddiscipline coupled with not an insignificant peer pressure, which accounts forthe very high motivation level in the DPAB petroleum worker.

Insurance

3.21 DPAB insures all its assets with the People&s Insurance Company ofChina. Insurance covers all major risks, including explosion and blowouts.The People's Insurance Company is in turn reinsured with internationalinsurance companies. These arrangements are satisfactory.

IV. THE PROJECT

Background

4.01 When the third well in Daqing struck oil in September 1959, Chinadiscovered its largest oilfield. This oilfield located in a geological basinknown as the Songliao basin, which lies mainly in the Heilongjiang province,has been a prolific producer and its current production level of about 51million tons of oil per annum accounts for one half of China's totalhydrocarbon production. Since its discovery, this oilfield has produced morethan 530 million tons of oil. The original oil-in-place in the Daqingreservoirs has been estimated at 3,000 million tons, of which 30% or about 900million tons is likely to be recoverable by the production technique presentlyadopted in the field. Higher recovery efficiency may be achieved if thereservoir responds favorably to one of the many enhanced oil recovery (EOR)methods and if this method or methods are economically viable.

4.02 In September 1981 the Government invited a Bank mission to visit theDaqing area, during the course of which Daqing oilfield development projectwas proposed which, inter alia, involved the development of the Gaotaizi (G)reservoir in Sa½ertu, one of the seven oilfields in Daqing. No oil productionhas been obtained from the G reservoir sands in Sa½ertu except for the oilproduced under the two pilot tests setup in 1979 to identify the optimum wellspacing patterns for the reservoir development.

Geology

4.03 The Daqing oilfield is situated in the central portion of theSongliao basin which is a large sedimentary basin of Mesozoic/Cenozoic age,covering approximately 25,000 square kilometers. Three distinct andindependent reservoirs; namely, the Sa ertu (S), the Putaohu (P), and the

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deepest Gaotaizi (G) can be discerned, each consisting of series ofinterbedding layers of sand and mudstones. Separately there are seven highculminations, sometimes termed as oilfields, in Daqing. While the G reservoirhas been exploited in most of these "fields", it has yet to be developed inthe Sa'ertu oilfield.

4.04 During the development of the Daqing field from 1960-1981, more than1,000 wells penetrated the G reservoir in the Sa'ertu oilfield. Datacollected from these wells were used in defining the parameters of the Greservoir. The Gaotaizi formation underlying this area has a gross thicknessof some 300 meters and lies at a depth of 900 to 1,200 meters; its aerialextent is 99 square kilometers (about 24,500 acres). The formation consistsof dark coloured shales interbedded with numerous thin fine-grainedsandstones. The shales have acted as oil source rocks and oil and gas haveaccumulated in the sands. The G reservoir has been divided into four sub-zones, designated G-I through G-IV. As much as 93 sand beds have beenidentified in these sub zones of the project area, but, due to theirdiscontinous nature, only about half of this number is likely to beintersected in any one well. The thickness of individual sand beds variesfrom a few centimeters up to six meters, but the average thickness is onlyabout 60 centimeters. Both sands and shales are deposited in a lacustrinedelta and are of lower Cretaceous age. The average sand porosity ranges from24.2 to 27.2% and the average permeability ranges from 60 to 161 millidarcy.It is possible that a greater deal of reservoir heterogeneity has been hiddenby the averaging of the data within the sub-zones.

Quality of Oil

4.05 The oil of the G reservoir has a specific gravity of 0.865 (about 32oAPI), a high wax content of 24.4% and a very high pour pointl/ of 300 C. Thuswhile the oil is fluid in the reservoir (at temperatures ranging from 500 to550C), it is solid at the ambient surface temperatures most of the year. Theoil, under reservoir conditions, is slightly undersaturated with natural gasand the solution gas oil ratio is around 44 standard cubic meters per ton(equivalent to about 200 cubic feet per barrel).

Production Potential and Project Design

4.06 Two small field pilot tests were set up in 1979 in the G reservoir totest the production potential and select the optimum spacing of the wells.The first pilot test used a spacing of 150 x 150 meters and the second oneused 250 x 350 meters spacing. Based on the performance of these pilot testsand a study carried out by the Daqing Research and Design Institute (RDI),DPAB prepared, in 1981, the feasibility study for the development of the Greservoir in the Sa'ertu field. RDI estimated the original oil-in-place inthe G reservoir at 137 million tons of which about 51 million tons, amountingto about 37% of the oil-in-place, would be recovered over a 20-year period.According to the projections made by RDI, peak production level of 3.8 milliontons per year will be reached after full development and maintained thereafter

1/ The pour point is the temperature at which the oil solidifies, orconversely, it is the temperature at which a solidified plug of oilcould be "poured" from a tube.

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for eight years. Further, well spacing of 250 x 350 meters was determined tobe more cost effective. In addition, DPAB prepared, in January 1982, aneight-volume "Plan for Development and Construction of the Gaotaizi OilReservoir in the Sa½ertu Field". This study covers in detail all aspects ofdrilling, construction and production engineering as well as proposals foreffective improvements over the entire oilfield including training centers,EOR methods, studies, etc.

4.07 The above studies were reviewed by the Bank's identification andappraisal missions. In addition, a technical review of the development planrelating to the G reservoir, was undertaken by Bank-financed consultants (CoreLaboratories). These reviews and the appraisal of the entity resulted in thefollowing modification/conclusions. With these changes, the proposed designwill represent the least cost method of developing the Daqing oilfield.

(a) It was confirmed that on the basis of the existing data, themost suitable method of developing the G resevoir was by waterflooding, using an inverted nine-spoti/ pattern with a wellspacing of approximately 300 meters. It would, however, benecessary to monitor the reservoir performance (using the modernequipment to be financed under the loan) and, if the data sosecured results in a different understanding of the oilproduction mechanism, appropriately modify the development planand production practices (well spacing, oil withdrawal rates,water injection pressure and rates, etc.);

(b) The recoverable reserves and projections relating to the annualproduction as estimated by RDI appeared optimistic. Accordingto the Bank consultants, the most probable scenario was of acumulative recovery of 32 million tons, out of an estimated 148million tons of oil-in-place, resulting in a recovery factor ofabout 22%. Further it may not be possible to sustain productionof 3.8 million tons per annum for more than a few years (forpossible production profiles see Annex 4.01). Given theheterogeneous nature of the G reservoir and the discontinuity ofindividual oil sands, it is not surprising that there areconsiderable variations in estimates of recovery and productionrates;

(c) Surface construction facilities as proposed by DPAB, need to bemodified. Consequent to the review of the proposals made by theconsultant, appropriate modifications have been incorporated inthe design. Future detailed studies on improving process flowof oil, gas and water and on metering of production will beinitiated and their results would be embodied in the projectimplementation. There is also a need to study the drilling andproduction practices and EOR methods applicable to the Daqingfield (paras. 4.14 to 4.17).

1/ Producing wells are drilled on the corners of a square and halfwayits sides, the ninth well is the water injection well placed at thecenter of the square. The distance between any neighboring producersis 300 meters.

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Project Objectives

4.08 The proposed project has three objectives: firstly, to develop the Greservoir in the Sa ertu oilfield by drilling and completing about 615 oilwells and about 206 water injection wells using up-to-date techniques andmodern equipment. The exploitation of the G reservoir will add at least some32 million tons of oil to the recoverable reserves of the Daqing field over aperiod of 20 years. The production of the G reservoir, expected to reach apeak of 3.8 million tons per annum, would partially offset the overallproduction decline to Daqing. In addition, seismic equipment will be providedto assist in identifying smaller reservoirs around the periphery of the greatDaqing field.

4.09 Secondly, (and more importantly) to use this project as a vehicle forinducting modern technology into Chinese petroleum industry. This is soughtto be achieved through various complementary modes. Modern drilling andproduction equipment will be imported. New operationally oriented researchlaboratories will be set up. A computer center will be established which will

assist the oilfield in gathering and processing data and undertaking oilfieldmonitoring. Thirdly, to make adequate provisions for the training of Chinesenationals. Two training centers with an annual capacity of 500 professionalsand 2000 skilled workers will be established. Besides formal training in thecentres and overseas training, on-the-job training will be effected throughservice contracts which will be concluded along with the purchase ofsophisticated equipment.

4.10 Furthermore, several studies will be financed under the project witha view to improving well drilling and completion techniques and optimizing thedesign and layout of the surface production facilities. Separately, and inorder to maximize the oil recovery, studies for the G reservoir and theapplication of enhanced oil recovery technology will be launched with the

possibility of setting up a field pilot. Further, the loan will finance pre-investment studies relating to the Zhong Yuan oilfield development project andother projects in the petroleum sector.

Project Description

4.11 The proposed project would comprise the following components:

(a) Gaotaizi Reservoir

(i) Wells

- Drilling and completing about 615 oil wells and about206 water injection wells to a depth of approximately1,250 meters and equipping them with the surface andsub-surface equipment;

(ii) Oil Production, Gathering, Treating and Transportation

Facilities

- equipping about 615 flowing and pumping wells withnecessary surface and subsurface facilities;

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- installing about 71 production metering stations;

- installing about 18 oil pumping stations and laying

about 760 kilometers of flow lines; and

- expanding appropriately the capacity of the threeexisting oil dehydration stations to accommodateadditional production from the G reservoir.

(iii) Associated Gas Gathering, Treating and TransportingFacilities

- Installing about 13 compressor stations and laying about

150 kilometers of gas lines; and

- installing three glycol gas dehydration stations and themain gas compressor station.

(iv) Water Injection Facilities

- Installing about 206 well-hydro facilities and threewater injection stations and expanding the existing oilywater treating stations; and

- laying over 100 kilometers of high-pressure waterinjection lines and about 40 kilometers of water supply

and drainage lines.

(v) General Utilities

- Installing three electric sub-stations, 220 transformers

and extending about 100 kilometers of high tension linesand 250 kilometers of low voltage distribution lines;

- constructing about 35 kilometers of paved roads with thenecessary culverts; and

- constructing lodging facilities with a covered area ofabout 64,000 square meters and field offices, warehouses

and service buildings with a covered area of about32,000 square meters.

(b) Training

Establishing a training center in Daqing field for

skilled workers and equipping it with a drilling rig,surface production equipment, simulators, visual aidsand a library; and

establishing a training centre for professionals at thePetroleum Institute and provision of the necessarylaboratory, teaching materials and foreign instructors.

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(c) Computer Center and Laboratories

- Establishing a computer center along with the necessary

hardware, software, peripheral equipment and services;

- Provision of an operationally-oriented research

laboratory for special core analysis, conventional coreanalysis, PVT (reservoir fluid analysis) and imbibitionand wettability;

- provision of a complete laboratory for EOR; and

- provision of a laboratory for oil, gas and watergathering, treatment and transportation.

(d) Seismic Equipment

- Provision of equipment for two digital seismic parties

exploration around the periphery of the Daqing oilfield.

(e) Technical Assistance

- provision of experts and services to perform studies on

the following fields of activity: (a) drilling andcompletion practices; (b) Gaotaizi geology and reservoirengineering; (c) fluid flow process design andoptimization of surface production facilities; (d)design of curricula for training and teaching methods;(e) oilfield safety practices, and (f) enhanced oilrecovery. Expatriate consultants needed to conduct theabove studies will be hired according to Bank guidelinesand on terms and conditions acceptable to the Bank.

(f) Zhong Yuan Oilfield and Other Studies

- undertaking a three dimensional seismic survey in the

Wenliu oilfield of Zhong Yuan and interpretation of itsresults and commissioning feasibility and design study

of an LPG plant in Zhong Yuan. In addition, undertakingpreinvestment studies which may be required for thepreparation of other petroleum projects in China.

Project Implementation

4.12 DPAB will have the overall responsibility for implementing the

project components related to Daqing; MOPI will be responsible for the smallcomponent of Zhong Yuan Oilfield and other studies. Under DPAB's supervision,PCN1 will be responsible for implementing the portion of the project whichrelates to the development of the G reservoir. The development design has

been evolved by RDI which will modify it and update it in accordance with theresults obtained from the reservoir study (para 4.14). Development drilling

will be carried out by the Drilling Company No. 2 and surface facilities willbe installed by a specialized construction company. Drilling and completionservices will be sub-contracted by the Drilling Company No. 2 to the Drilling

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Services Company and the Down Hole Services Company respectively. PCN1 is awell-managed company. Its normal annual work program relating to the drillingof new wells is in excess of the program stipulated under the proposedproject. Similarly, the relevant drilling services and surface constructioncompanies have the requisite experience and management capabilities to carryout effectively their respective tasks under the project. However, forcoordinating and monitoring the development program relating to the Greservoir, it would be necessary to establish a special project team inPCN1. During negotiations assurances were obtained that DPAB will establishsuch a team in PCN1 by March 31, 1983, which would be headed by a DeputyDirector. DPAB will be directly responsible for implementing the remainingcomponents of the project, with the exception of preinvestment studies,including preparation of the Zhong Yuan project. For greater detail see para.3.04 to 3.11.

Drilling and Production Practices

4.13 Further, during appraisal it appeared that some of the drilling andproduction practices currently being applied at Daqing are suboptimal. Thepresent evidence suggest the need for closer evaluation of field practices andthe desirability of modifying some of them; more so as the need for Daqing arechanging on account of it having reached a mature stage of development. Theseissues are dealt with in the ensuing paragraphs.

4.14 Reservoir Study. The Daqing oilfield is characterized by the absenceof a large acquifer, hence there is no appreciable water drive to supplementthe natural energy. In addition, the reservoir oil is unsaturated with gas byabout 20 atmospheres and the compressibility of the reservoir system (oil,water and rock) is quite low in view of the shallow depth. Hence, theproduction methods at Daqing throughout its 20-year history have involvedinjecting water in the reservoir, keeping the reservoir pressure at or abovethe original level, in an attempt to improve the recovery efficiency. It isestimated, however, that more than 70% of the oil will be left in the groundif only the water flooding is applied. In order to increase the recoveryefficiency of Daqing, it is necessary to fully understand, monitor and controlthe reservoir behaviour. A reservoir engineering study is needed whereby thegeological characteristics of the many oil sand beds are investigated, theircontinuity or discontinuity between wells established, and their conductivityto oil and water measured in the laboratories and the field. Data collectedin the field on individual wells behaviour and production patterns over timewill supplement mathematical models and laboratory measurements. The resultof the reservoir study should help optimize production and injection rates,suggest the most economical well spacing, and propose remedial measures to betaken to-minimize the by-passing of oil by water. The loan contains financialprovision for undertaking this study with the assistance of qualifiedexpatriate consultants. Its results and consequent impact on the projectdesign will be reviewed with the Bank; the study will be completed by December31, 1983.

4.15 Enhanced Oil Recovery (EOR). Daqing oilfield has reached a maturestage in its life, the water cut is increasing and the overall productionlevel is anticipated to decline. It is, therefore, necessary to evaluate therelevance and applicability of various EOR methods. However, application ofthese methods to a large reservoir such as Gaotaizi involves substantial

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financial outlays and carries considerable technical risk, particularly inview of the characteristics and uncertainties of many EOR processes. Beforeconsidering any field application, it would be necessary to undertake a stagedfeasibility study which would follow the classical approach of: (a) screeningthe various processes; (b) conducting a feasibility study; (c) runninglaboratory experiments; and (d) applying one or more processes on a pilotscale. The data collected from the reservoir study would constitute animportant input for the EOR pilot design. The first three stages of the studywould be completed within one year of its initiation (by December 31, 1983);the EOR pilot design and its application would be carried out over the nexttwo years. The results of all four stages and further course of action wouldbe reviewed with the Bank; the study will be completed by December 31, 1985.

4.16 Review of Process Flow Design and Optimization of Surface Facilities.The Daqing crude oil has a wax content of 24% and a pour point of 3OoC. Thehandling of the oil is particularly difficult in view of the severe winterconditions in the area. Moreover, the water cut of the produced fluid inDaqing is averaging 60% and it is increasing. Oil-water emulsion is treatedwith heat, chemicals and high electric voltage. The oily water separated fromthe produced fluid is cleaned and mixed with additional water from nearbysources and the resulting mixture (in excess of one million barrels per day)is reinjected in various oil reservoirs to sustain their pressures. Thevolume of the fluids (oil, water and gas) is indeed immense and the amount ofenergy spent in heating and moving them is quite high. Besides, the accuracyand frequency of the metering of the individual production/injection wells isessential for reservoir monitoring and performance prediction. Further,reservoir damage could result from injecting water incompatible with thereservoir fluids or at a temperature low enough to adversely affect fluid flowin the reservoir. However, prior to ordering equipment and material, it isnecessary to carry out a detailed design study relevant to the productionproblems of Daqing. A proto-type station could be assembled thereafter and iffound cost effective, similar improvements could be replicated in otherproduction centers. The proposed loan contains a provision for the designstudy, and for metering, separation, dehydration and pumping equipment andinstrumentation for at least one station. DPAB has agreed to undertake such astudy through qualified consultants. The results of the said study will bereviewed with the Bank and the consequent plan of action will be agreed upon;the study will be completed by July 31, 1983.

4.17 Drilling and Completion Practices. High density mud is used indrilling the Daqing wells in an attempt to control high pressure in relativelyshallow zones. The mud weight used in Daqing appears too high for theformation pressure; likewise, cement slurry density needs to be lowered.Further, the drilling rigs should be equipped with mud tanks to ensure propermonitoring of fluids going into and out of the wells. The drilling andcompletion practices adopted in Daqing may lead to formation damage and mayalso necessitate resorting to fracturing of the reservoir which may otherwisebe unnecessary. DPAB has agreed to appoint consultants to review the aboveaspects with a view to evolving by May 31, 1983, a package of field practicesconsistent with the needs of Daqing and modern petroleum technology. Theproposed study would be financed out of the proceeds of the loan and itsfindings will be reviewed with the Bank and further course of action will beagreed upon.

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Implementation Schedule

4.18 The project implementation schedule is shown in Annex 4.02. Becauseof the severe weather conditions in the area, the drilling of wells is donebetween the middle of April and early November and surface construction mustcease by December. Drilling of the wells will start during 1982 and the totalof 821 wells will be drilled by the end of 1985. The implementation plan wasreviewed with DPAB so as to reduce the time gap between completion of the welland production of oil. This would require accelerating the construction ofsurface facilities. The revised implementation schedule would be reviewedduring negotiations. It is expected that the entire drilling and surfaceconstruction program would be completed by the end of 1985 and the estimatedfull production capacity of 3,800,000 tons could be reached by 1986.

Project Costs

4.19 The proposed project is estimated to cost an equivalent of US$674.3million, including physical and price contingencies, of which US$228.4 millionor 34% represents the foreign exchange component. A physical contingency of7% was applied to the cost of all imported equipment and materials and 15% wasapplied to all local costs. A relatively low physical contingency rate wasapplied to foreign costs in view of the fact that most of the importedequipment provided under the project has already been identified. The basiccost estimate is based on 1982 prices; price escalation both for local andforeign costs have been assumed at 8% for FY 82 and 83, 7.5% for FY 84, 7% forFY 85 and 6% for FY 86.

4.20 The overall project cost is much lower than similar projects in otherdeveloping countries due to: (a) the long experience and good planning inconstructing similar projects in Daqing; (b) the utilization of localequipment with relatively low level of depreciation allocated by DPAB ascompared with international drilling and construction contractors; and (c) theextremely low level of salaries and wages in China (the salary of a toolpusheris about one hundredth of his counterpart in U.S.A.). The cost of importedequipment was estimated according to budget estimates provided by suppliers inDecember 1981 and January 1982.

4.21 For estimating the cost of consultant services (466 man-months) forspecial studies and technical asistance, a man-month rate of US$17,000 wasassumed for personnel based in the home office and US$20,000 (which isinclusive of travel and subsistence) for staff assigned to China. These ratesare deemed to be both reasonable and in line with current charges prevailingin the petroleum industry. The cost of laboratory analysis, specializedequipment and services, and computer time was added to the straight man-monthcosts wherever such services were required. The cost of service contracts forhighly specialized equipment such as formation and production logging,cementing and fracturing equipment are included in equipment costs.

4.22 The estimated project cost is shown in the following table. Annex4.03 gives a detailed breakdown of the project cost.

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PROJECT COSTS1!

Yuan Million US$ MillionItem Local F.E. Total Local F.E. Total

(a)Gaotaizi ReservoirWell Drilling 222.3 158.4 380.7 123.5 88.0 211.5Production Equipment andServices 69.7 61.2 130.9 38.7 34.0 72.7

Oil Gathering and Transport 95.8 14.4 110.2 53.2 8.0 61.2Gas Gathering and Transport 70.9 -- 70.9 39.4 -- 39.4Water Handling and Injection 25.7 -- 25.7 14.3 -- 14.3Utilities and General FieldEquipment 53.1 -- 53.1 29.5 -- 29.5Field Buildings and WorkersHousing 23.4 -- 23.4 13.0 -- 13.0

(b)Training Centre 9.9 10.8 20.7 5.5 6.0 11.5(c)Laboratories 2.5 7.2 9.7 1.4 4.0 5.4(d)Equipment for two seismic parties 1.8 12.6 14.4 1.0 7 8.0(e)Computer 4.8 25.2 30.0 2.7 14.0 16.7(f)Technical Assistance

- Reservoir & EOR Studyand Pilot Project 8.8 10.8 19.6 4.9 6.0 10.9

- Other than EOR and training 0.5 5.4 5.9 0.3 3.0 3.3(g)Seismic work for Zhong Yuan &

Technical Assistance for ZhongYuan and Other Projects 1.8 12.6 14.4 1.0 7.0 8.0

591.0 318.6 909.6 328.4 177.0 505.4Physical Contingencies 88.7 22.5 111.2 49.3 12.5 61.8Price Contingencies 122.8 65.7 188.5 68.2 36.5 104.7

Total Project Costs 802.5 406.8 1209.3 4435. 226.0 671.9Front End Fee - 4.3 4.3 - 2.4 2.4

Total 802.5 411.1 1213.6 445.9 228.4 674.3

Project Financing

4.23 It is proposed that the Bank loan of US$162.4 million equivalent bemade to the Government of China for a period of 20 years inclusive of a graceperiod of five years, which are the standard country terms. GOC will onlend$153.9 million to DPAB on the same terms and conditions under a subsidiaryloan agreement. Foreign exchange risk and variable interest risk will beborne by DPAB.

4.24 The proposed Bank loan represents 71% of the foreign exchange cost ofthe project and 24% of the total project costs. The uncovered gap of $66million represents the cost of tubular goods and could be covered if DPABsecures suppliers' credits for these items. In the event suppliers' credits

1! Includes import duties (estimated at 15% of the cost of foreign goods)amounting to $28 million.

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do not become available, GOC/DPAB will cover the foreign exchange gap from itsown resources. All local costs equivalent to US$445.9 million (Yuan 802.5million) will be provided by GOC/DPAB.

Allocation and Disbursement of Bank Loan

4.25 The proposed Bank loan of US$162.4 million would finance 100% of theforeign expenditure for consultants' services and training programs, 100% ofthe foreign exchange cost of imported goods with the exception of casing andtubing for which no Bank financing will be provided, and 100% of the localcost (ex-factory) of equipment which will be supplied from local sources underICB. Annex 4.04 provides a detailed breakdown of the allocation of Bank loan.

4.26 Disbursement of the Bank loan for: (a) material, equipment, meteringand instrumentation for the production stations; and (b) EOR pilot test iscontingent upon the completion of the relevant feasibility studies and itsreview by the Bank.

4.27 Disbursement of the Bank loan is expected as follows:

IBRD Fiscal Year 1983 1984 1985 1986US$ Million

Incremental 30 90 30 12.4Cumulative 30 120 150 162.4

A high rate of disbursment is foreseen for FY 84 since most of the equipmentand services will be purchased in that year. Annex 4.05 provides a detailedbreakdown of the disbursement schedule.

Procurement,

4.28 Drilling and construction work would be carried out by force account(DPAB's own force) with Bank financing only goods and services. This practicehas been shown to be cost effective (para. 4.20). Goods and services financedunder the proposed Bank loan would be procured by international competitivebidding (ICB) in accordance with the Bank guidelines or by limitedinternational tendering (LIT) or by direct purchase. ICB procedures would bemostly suited to equipment produced by many manufacturers, such as drillingand workover rigs, drilling tubulars and materials, oil-gas separators andtreaters. It will be appropriate to use limited international tendering forhighly specialized or proprietary equipment of formation and productionlogging, cementing and hydraulic fracturing, seismic equipment and submersiblepumps; in each case quotations will be requested from qualified internationalcontractors known to provide such equipment. In view of the high percentageof proprietory and specialized equipment provided under this project it isforeseen that disbursement under ICB and LIT would represent about 40% and 50%of the total loan respectively. In addition direct purchases for spares,equipment and instrumentation costing less than US$150,000 equivalent may beprocured through direct purchase up to an aggregate amount of US$5 million (3%of the Bank loan). All bid packages having value of US$500,000 or above wouldbe subject to Bank review prior to contract award; other packages would bereviewed subsequently.

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Training

4.29 The project covers the establishment of two training centers, one forprofessionals and one for skilled workers with an initial annual capacity of500 and 2,000 trainees respectively. The training centers would provideand/or secure:

(i) basic training for skilled workers and would offer courses indrilling, production, well logging, cementing, mud,instrumentation, pipe fitting, welding, laboratory, etc.;

(ii) professional training in various areas of petroleum engineering(except drilling engineering which is offered at Shengli),petroleum economics, systems analysis, geology and geophysics;

(iii) periodic refresher courses for both professionals and skilledworkers to ensure that they keep abreast of the latest technologyand techniques;

(iv) language courses, especially for professionals and specialistsselected for foreign training;

(v) foreign training of selected professionals and inviting foreignspecialists to the Daqing training centers; and

(vi) equipment, training aids, laboratories, teaching material andother facilities necessary for imparting various categories oftraining envisaged under the said centers.

4.30 In addition to formal training in the centers (for details see Annex4.06), on-the-job training of professionals and technicians would beaccomplished through: (a) professinals working closely with consultants hiredto conduct various studies on reservoir engineering, EOR, drilling andproduction practices and surface process engineering; and (b) techniciansworking under the supervision of expatriates hired through service contractsto operate and maintain equipment supplied under the proposed loan.

4.31 DPAB has agreed to build a training center for skilled workers in theDaqing field with a covered area of approximately 2600 M before October 1,1983. DPAB will also equip this center with a complete drilling rig, workoverrig, pumping units, welding sets, and other locally available relevantmaterial and equipment. The professionals' training center will be attachedto the existing Daqing petroleum Institute and enough space should be providedfor this purpose. Bank-financed consultants have undertaken a preliminarystudy of the existing training program at DPAB and the recommended curriculaare outlined in Annex 4.06. Assurance were obtained from DPAB that it wouldundertake a study by training experts to design the detailed trainingcurricula and teaching methods at DPAB. The study would be completed byJanuary 31, 1984 and findings would be reviewed with the Bank and the

consequent action plan agreed upon. Further, to ensure that this trainingcenter has access to appropriate and modern teaching methods and materials,DPAB intends to enter into collaboration with a foreign university for alimited period of time.

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Laboratories

4.32 DPAB-s need for refurbishing existing laboratories and/or establishingnew laboratories was reviewed by a Bank consultant (French PetroleumInstitute). It was considered necessary to distinguish between laboratorieswhich would carry out operationally-oriented research under RDI and the fieldlaboratories with various companies which perform purely operationalfunctions. For laboratories under RDI additional equipment will be providedfor: (i) pressure-volume-temperature (PVT) analysis for oil and gas; (ii)special core analysis; (iii) core wettability and imbibition; and (iv)enhanced oil recovery (EOR) (para. 4.15). In so far as the field laboratories

are concerned, the equipment in the mud, cement and fracturing laboratorieswere found adequate. The project, however, caters for establishing an oil,

gas and water analysis and evaluation laboratory with PCN1. The equipment forthe latter laboratory would be basic in nature which would permit the companyto undertake routine testing necessary for the execution and control of theproject.

Computer Facilities

4.33 The existing computer at Daqing is inadequate for the oilfieldrequirements. However, before selecting new computer and anciliary software,it would be necessary to determine the precise functions which need to becomputerized, the appropriate size and configuration of computer(s) requiredto perform these functions and the availability and type of softwarerequired. A Bank consultant joined in the post appraisal mission (mid-May,1982) to help in assessing these needs and drawing up a requirement sheet tobe used as a basis for soliciting bids for hard and software. Summary of theconsultant-s report is shown in Annex 4.07.

Project Risks

4.34 The Gaotaizi resevoir has been penetrated by over 1,000 wells whichwere drilled to exploit other reservoirs in the Sa'ertu field. Such a largenumber of control points should normally provide enough assurance of therecovery rate. However, the Gaotaizi oil sands are thin, tight anddiscontinuous streaks dispersed in deltaic mud stone. Estimates ofrecoverable reserves vary from over 50 million tons to 29 million tons andless; but the project is highly profitable even with the lower, conservativeestimates (see para. 6.06). Further, the utilization of modern equipmentsupplied under the Bank loan and the provision of technical assistance forvarious studies would reduce operational risks, improve oil recoverytechniques and help increase the recovery efficiency to reach the higher levelestimate.

4.35 The project carries operational risks inherent to the petroleumdrilling and production industry. The low level of safety practices adaptedin the drilling operations and the absence of the blow out preventers from thewell head aggravates risks to human life and equipment. For attenuating theserisks a review of DPAB-s safety practices is envisaged under this project.

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Ecology and Safety

4.36 The DPAB drilling and production operations pose a minimal threat tothe ecology. Oil and liquid wastes would be the major concern. However, allsuch wastes are kept in closed systems and treated before disposal. Safety

measures, as currently practised in Daqing, appear inadequate. Drilling rigslack blowout preventors and explosion proof lights; there is inadequate care

and protection of electric power cables; and the derrick floors are dirty andpoorly organized. Fire prevention equipment is minimum and seems insufficient

to prevent or contain a major oil fire. Even such safety regulations asexist, are seldom enforced in the field. The incidence of accidents is

relatively high.

4.37 The Bank has expressed its deep concern over the problem of safety in

Daqing. It was agreed that a Bank-financed safety expert well versed in thepetroleum industry standards would visit Daqing and report on his findings for

the improvement of safety in the oilfield operations. The study will becompleted by June 30, 1983; the Bank and DPAB would review the consultant'srecommendations and come to an agreement on a plan of action.

Reporting Requirements

4.38 Annual and quarterly project progress reports would cover: (i)

technical progress; (ii) cost estimates, expenditures and disbursements; and(iii) management and operations. The purpose of these reports is to provideinformation on: (i) physical work accomplished during the reporting period;(ii) comparison of the actual progress of construction and related costs withthe original estimates; (iii) the expected dates of completion of theprincipal physical elements of the project, and (iv) improvements including

operating efficiency resulting from the implementation of the consultants-recommendations emanating from the various studies. The format and content of

the progress reports were discussed and agreed at negotiations.

V. FINANCES

Introduction

5.01 Given DPAB-s diversed activities, the scope of project entityappraisal has been limited to oilfield operations and this chapter covers therelated financial aspects.

5.02 DPAB performs a triple role for GOC; it is GOC-s largest producer of

crude oil; one of GOC's larger fiscal providers; and indirectly, a foreignexchange provider. Since DPAB is operating in a centrally planned economy inwhich all the factors of production are tightly controlled, two fundamentalaspects - financial autonomy and performance measurement - differentiate DPABfrom a similar enterprise in a market economy. While DPAB enjoys considerableoperational autonomy, it is far more constrained in financial autonomy.Specifically, GOC (i) sets DPAB's annual production and net income targets;(ii) approves DPAB-s operational and investment budgets; (iii) setsregulations for the conduct of DPAB-s financial management; and (iv) setsdetailed reporting requirements with which DPAB has to comply. DPAB-s

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performance is measured on the basis of product output under given budgetparameters, rather than on profitability. Fundamental differences existbetween some of the DPAB practices and the financial accounting practices ofcommercially oriented petroleum enterprises (para. 3.12 and 5.05). Underthe'se circumstances, any assessment of DPAB's financial performance based onfinancial norms usually applied to a similar enterprise in a market economywould be of limited significance. Financial appraisal of DPAB has thereforebeen concentrated on costs (para. 5.07) and cash generation (para. 5.08),together with internal controls (para. 3.15), budgetary controls (para. 5.04)and incentive system (para. 3.19).

5.03 The basis for DPAB's financial operations is the annual budgets andin this respect:

(i) DPAB is required to prepare an annual investment and fieldmaintenance budget to meet the production target set by MOPI. Theplan is subject to the approval of both MOPI and the State PlanningCommission.

(ii) DPAB is required to prepare an annual operating budget based on thetargets set by MOPI. The target parameters focus mainly onproduction level, costs, and net income, on a monthly, quarterly, andannual basis. The budget is prepared in detail down to the level ofbrigade and is reviewed and consolidated at the operating company andthen at the bureau level. The consolidated budget of DPAB's overalloperation is subject to the approval of MOPI and review by MOF.

(iii) DPAB's level of working capital is set by MOPI who allocates thefunds to DPAB free of charge. In the event that requirements exceedthe approved levels, DPAB can borrow additional funds on a short termbasis from the People's Bank; the current interest rate for thesefunds is 3.6% per annum.

5.04 Reflecting GOC's requirements, DPAB's financial and accountingoperations have special features, the principal of which are summarized below:

(i) DPAB's production is marketed as directed, and at prices fixed byGOC. No price distinction is made between crude sold for thedomestic market and crude sold for export. As regards the latter,DPAB is required to sell crude to a GOC Agency, who in turn resellsit on the international market. Current price paid to DPAB for crudeis Y100 (US$55.6) per ton which is about 30% of current internationalprice of US$200 per ton for similar crude.

(ii) DPAB is permitted to charge as expense sums up to approved yearlybudget limits (under two main categories)- for field maintenance,

1/ Oil field uphold funds - based on a certain unit cost of plannedproduction: these funds may be used for new investment; unused funds maynot be carried forward to future years.Oil field overhaul funds - based on a certain percentage of gross fixedassets; these funds may be used for maintenance and repairs. Unused fundscan be carried forward to future years.

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renewal and development before computing net income. Over the lastthree years these expenses have on average amounted to about 11% ofnet revenues. However, given the declining rate of production fromthe Daqing field, such expenses are expected to increasesubstantially in the future since they are DPAB's main sources forfield maintenance and development.

(iii) DPAB is required to transfer all net income and 50% of annualdepreciation to GOC. The balance of depreciation is retained by DPABfor new oilfield investment; unused funds can be carried forwardbeyond the budget year.

(iv) GOC covers the approved cost of exploration, and also makes specificcontribution to development. Other development costs are met byDPAB, as noted in sub-paragraphs (ii) and (iii).

Past Finances

5.05 A summary of DPAB's financial performance for the three-year periodFYs78-80 is given below. These figures are based on the current accountingpractices of DPAB; further details are given in Annexes 5.01 and 5.02.

FY78 FY79 FY80

Production

- Crude oil (million tons) 50.4 50.8 51.5

Sales - Volume

- Crude oil (million ton) 48.4 49.6 49.6- Natural gas (billion m ) 5.0 5.0 5.0

Price

- Crude oil (US$/ton3 58.3 58.5 58.8- Natural gas (US$/m ) 0.03 0.03 0.03

US$ Million

Revenues - net of sales tax 2,698 2,773 2,784

Expenses 561 712 769

Net Income 2,137 2,061 2,015

Unit Cost of Production

(US$/ton) 11.14 13.82 15.28

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5.06. Despite a modest growth in sales revenue over the period FYs78-80,net income showed a slight decline; FY78--US$2,137 million, FY79--US$2,061million and FY80--US$2,015 million. The stabilization of crude production atabout 50-51 million tons per year was only achieved at increasing cost. Thehigher costs of extracting oil from a field which has been operating for over20 years were reflected in a 37% increase from US$11.14 per ton in FY78 toUS$15.28 per ton in FY80. Since prices did not accompany the increased costsof production, DPAB's margins on crude decreased from US$47.16 per ton in FY78to US$43.52 per ton in FY80. Nevertheless, despite crude prices which werewell below international levels, and declining margins, DPAB-s transfers offunds to GOC have been substantial.

5.07 DPAB's financing arrangements for field production facilities havebeen sound. Over the period FY78-80, DPAB has financed from its own resources82% of the outlay (US$1.1 billion) for the investment in and maintenance ofthe production facilities of the Daqing field and over the same period has, inaddition, transferred to GOC US$6.4 billion from surpluses and depreciation

charges (see para. 5.05 (iii)). Taking into account GOCs direct contributionof US$200 million to investment over the three year period FY78-80, the ratio

of Government take to overall outlay in the field was about 5.6:1. This ratiowould be much higher if the State sales tax (US$435 million) and the profit on

the export of DPAB's crude were to be taken into account. A statement ofactual funds flow between DPAB and GOC us given in Annex 5.06.

Capitalization

5.08 DPAB does not have any long term debt. DPAB's capitalization isrepresented entirely by GOC contributions and retained funds from internalcash generation. As of end-FY80, DPAB's net worth in the oilfield totalledUS$1.2 billion representing US$1.1 billion in field production assets andUS$0.1 billion in working capital.

Investment and Field Maintenance Program FY81-85

5.09. In an effort to arrest the production decline of the Daqing oilfield,DPAB has prepared an investment and field maintenance program totalling aboutUS$4 billion covering the five-year period FY81 through FY85; this outlay,which represents almost a threefold increase in the average annual outlay for

the period FY78-80, would include the drilling of about 5,000 wells andconstruction of the related service facilities. The proposed G reservoirproject, which is estimated to cost US$674 million, would form part of theprogram and would represent about 17% of the total program cost. Thetentative financing plan for the program, as provided by DPAB, is as follows:

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(US$ Million)

Total FY81 FY82 FY83 FY84 FY85

Internal Funds

DPAB (82%) 3,338.0 476 652 741 737 732.0GOC (14%) 576.1 166 123 - 129 158.1

(96%) 3,914.1 642 775 741 866 890.1

External Funds

IBRD ( 4%) 153.9 - - 90.0 45 18.9

Total (100%) 4,068.0 642 775 831.0 911 909.0

DPAB's projections assume that with the proposed outlay, production levels ofthe overall Daqing field will be maintained until at least 1986 at about 50million tons per year which is slightly lower than current production (51.75million tons). DPAB's estimated production figures are as follows:

Total

FY81-85 FY81 FY82 FY83 FY84 FY85

Est. crude production(million tons) 253.3 51.75 51.5 50.0 50.0 50.0

The reservoirs of the Daqing oilfield are complex and the producing sands areheterogeneous. Only when the proposed program of assistance to DPAB is wellunderway will it be possible to determine how the reservoirs have beenexploited or to predict how the field will respond to new practices andparticularly the new enhanced recovery methods which are being considered byDPAB. DPAB's forecast of production could be quite realistic. However, forthe purpose of financial forecast, it has been assumed that the production ofcrude from the existing field would decline by 7% per year after FY82, but asfrom end-FY83 production would be supplemented by crude from the G reservoir.

Pricing

5.10 Crude at Daqing is presently priced by COC at US$56 per ton, which iscommon to most of the oilfields in China (para. 2.32). On the basis of thisprice, it is estimated that DPAB could continue to finance its operational andmaintenance costs, as well as a portion of its investments, and still providesurpluses, although on an increasingly reduced scale to COC within thisdecade. Based on the assumptions that production would continue to decline by7% p.a. and production costs increased by 9% p.a. from FY86 on, DPAB'scontribution is projected to decline significantly from the present level ofUS$2 billion annually to about US$440 million by FY90. Taking account of the

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rising costs of oil extraction in the country, MOPI has recently proposed anincrease in the price of crude to US$97 per ton throughout China. The impactof such a price increase on DPAB would be to significantly increase its fiscalcontribution to GOC. As an example, in 1985, this contribution could be aboutUS$2.8 billion compared to about US$1 billion based on the existing price.DPAB's operating ratio in 1985 using the existing price would be about 54%against about 31% should the above increased price be effective in that year.

5.11 Based on the conservative forecast of production and the increasedprices of crude from FY84, DPAB's estimated financial performance for theperiod FY81-85 is expected to be as shown below. Detailed forecast financial

statements (Income Statements, Balance Sheets and Sources and Application ofFunds Statements) are given in Annexes 5.03, 5.04 and 5.05.

Production FY81 FY82 FY83 FY84 FY85

Crude oil (million tons) 51.75 51.5 48.1 45.6 43.7

Sales - Volume

Crude oil (million tons) 49.4 49.4 45.7 43.3 41.9Natural gas (billion m3) 5.2 5.2 4.8 4.6 4.4

Price

Crude oil (US$/ton) 58.8 55.6 55.6 97.2 97.2

Natural gas (US$/m3) 0.03 0.03 0.03 0.072 0.072

US$ million

Sales - net of sales tax 2,774 2,624 2,427 4,030 3,900

Expenses 856 1,003 1,076 1,135 1,196

Income before interest 1,918 1,621 1,351 2,895 2,704

Interest 4 7 16 19 20

Net Income 1,914 1,614 1,335 2,876 2,684

Est. Unit cost of crudeproduction (US$/ton) 16.5 19.5 22.4 24.9 27.3

5.12. The forecasts indicate that until the revised crude price isintroduced in FY84, DPAB-s annual net income would continue its decline: inFY82 by 7% and in FY83 by 16%, over previous year's level. Following theprice increase, net income would increase by 115% in FY84 as compared withFY83; however, a resumption of the annual decline would follow after FY84, asa result of the continuing increased cost of extracting oil from the field.Estimated unit costs of production of crude would be expected to increase by64% from about US$16.5 per ton in FY81 to about US$27.3 per ton in FY85 (seeAnnex 5.07). Margins per ton of crude would be as follows:

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FY8'1 FY82 FY83 FY84 FY85

US$ per ton 42.3 36.1 33.2 72.3 69.9

5.13. Over the five-year period to FY85, DPAB would continue to cover thebulk (82%) of its own investment and field maintenance requirements (seepara. 5.10) and continue to make large contributions (US$10.9 billion) toGOC. However, taking into account GOC's proposed contribution to investmentof US$576 million, the ratio of GOC's take to total outlay would only be2.7:1, almost one-half of the ratio for the three year period FYs78-80 (seepara. 5.08). A statement of estimated funds flow between DPAB and GOC isgiven in Annex 5.06.

G Reservoir Development Project

5.14. Production of crude from the G reservoir which is expected topartially offset the decline in production from the overall Daqing field willcommence in late FY83, and reach a peak of about 3.8 million tons in FY87. Atthat time, the G reservoir should be contributing about 9% of the productionof the overall Daqing field. DCF rate of return on the project is estimatedat 36% (in real terms) over the life of the project. Comparative productionfigures for the G reservoir and the overall Daqing field for the periodFY81-85 are given below:

(In million tons)

% ofFY81 Total FY82 % FY83 % FY84 % FY85 %

G Reservoir - - - - 0.2 - 1.1 (2) 2.1 (5)Remainder ofDaqing field 51.75 (100) 51.5 (100) 47.9 (100) 44.5 (98) 41.6 (95)

Total Daqingfield 51.75 (100) 51.5 (100) 48.1 (100) 45.6 (100) 43.7 (100)

5.15. Notwithstanding that depreciation charges per unit of production forthe G reservoir in its early production life will be substantially higher thanthose for the overall field, the unit costs of production of the G reservoirare expected to be lower; this is due to G reservoir's higher initialproductivity rate per well. Comparative unit costs of production for theoverall Daqing field and the G reservoir for the period FY84-85 are givenbelow:

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Unit Cost of Production (excluding interest)

(US$/Ton)

Overall Daqing Field

FY84 % FY85 %

Total 24.9 (100) 27.3 (100)

Operating Cost 20.9 (83) 22.7 (83)Depreciation 2.5 (10) 2.6 (9)Others 1.5 (7) 2.0 (8)

G Reservoir

Total 24.1 (100) 24.3 (100)

Operating Cost 8.1 (33) 8.3 (34)Depreciation 16.0 (67) 16.0 (66)

Performance Measurement

5.16 Within the context of financial arrangements in China, DPAB-sfinances are sound; DPAB has produced, and on present prices should continueto produce, large surpluses. It has a very high self-financing ratio, a lowoperating ratio, and as of now no long term debt. On present arrangements,DPAB, by most standards, warrants a high credit rating. However, since DPABis not operated on a typical commercial basis, its financial performanceespecially in regard to operating efficiency cannot be measured in the samemanner as a commercially oriented enterprise, and the application of theBank's normal financial covenants would be of limited significance. For thesereasons, it would be difficult if not impossible to formulate meaningfuloverall quantitative performance covenants. The internal control system atDPAB is satisfactory (para. 3.15) and bonus reward is being tied in withperformance (para. 3.19). Nevertheless, the various studies provided by theproposed project are directed at improving the operational efficiency of DPABand the implementation of the recommendations resulting from these studieswould be followed up during the supervision process (Chapter IV).

5.17 The overall benefits which will be brought to DPAB through theproposed loan cannot be measured in terms of financial targets monitoredthrough financial covenants. The main benefits will not be seen during theimplementation period of the project but will accrue over a wider span of timefrom a large number of improvements of a technical nature and at a micro levelin DPAB's operations. Eventually, however, they will accumulatively showthemselves, through higher production than would have been otherwise, alengthening of the production life of the Daqing field and lower costs ofindividual technical operations.

5.18 DPAB is a large and complex organization. PCN1, a sub-unit of DPAB,has overall responsibility for developing the G reservoir from which all thequantifiable benefits of the project are derived. PCNI is a large oil company

- 50 -

by any measure, with its current annual output in the order of 10 milliontons. During negotiations, assurances were obtained from DPAB that it wouldreview with the Bank by October 1 of each year, starting from 1983, thecurrent and projected finances of PCN1, focusing in particular on its trend ofproduction costs, budget variance analysis, as well as its future investmentprogram and related financing arrangements.

VI. ECONOMIC ANALYSIS

Background

6.01 The development of the G reservoir of the Daqing oilfield willprovide China with incremental supply of oil for domestic consumption and/orexport, and of gas for domestic use in a petrochemical plant. The projectwill also upgrade the level of technology and skills in petroleum engineeringand geophysics. The Government has placed a high priority on thisdevelopment. While the project is the least cost method to develop the Greservoir (see para. 4.07), lack of sufficient knowledge of the alternatives,makes it impossible to prove or disprove that it represents the best availablealternative to increase petroleum production in China. Nonetheless, theproject is highly attractive according to all economic criteria (see para.6.06).

Project Costs

6.02 The costs of the project include the capital expenditures (86% oftotal project costs) and operating costs directly related to the developmentof the G Reservoir, including: (i) the oil producing and water injectionwells; (ii) the oil gathering and transportation system; (iii) the gasgathering and treatment facilities; (iv) the water injection system; (v)utilities; and (vi) housing. For the purpose of economic analysis, the costsof cement and steel, the two major inputs, have been shadow-priced atinternational values with conversion factors of 1.1 and 1.7 respectively. Inaddition, the power component of the operating costs has been shadow-priced atYO.20/kwh to reflect the scarcity of electricity in China. However, domesticlabor (3% of total production costs) has not been shadow-priced in the lightthat skilled workers wages are deemed to be representative of their values,and unskilled labor costs constitute only a nominal portion of the totalproduction costs. The official exchange rate at the time of appraisal ($1 =Y1.8) has been used for all conversions. All costs are expressed in constant1982 dollars.

Project Benefits

6.03 The main quantifiable benefit from the project will be the productionof crude oil. For the purpose of economic evaluation, crude oil value hasbeen estimated at the current international price of $200/ton. This price isassumed to increase thereafter by 3% per year in real terms. Freight costsfrom Daqing to the closest port have been estimated at $5 per ton. The gas isvalued at the Btu equivalent of naphtha ($0.28/M3) which it replaces as apetrochemical feedstock. The production profile for the base case has been

- 51 -

taken according to the consultant's most conservative estimate of productionfrom the reservoir; these estimates are summarized below:

Table 6.01: Base Case for Economic Analysis

1984 1988 1992 1996Oil Production (000 metric ton) 1122 3542 1790 1107Gas Production (Million m ) 48 152 751 47

Economic Rate of Return and Net Present Value of Project Benefits

6.04 Detailed economic analysis is shown in Annex 6.01. Based on theabove assumptions, the economic rate of return would be 91%. The net presentvalue, at a 12% discount rate, is estimated at $2.4 billion over the life ofthe project. These values are high partly because this is a petroleumdevelopment project which benefits from the "sunk costs" of exploration in theDaqing Oilfield.

Sensitivity Analysis

6.05 Due to several uncertainties in regard to the reservoir behavior, andespecially concerning the recovery ratio (see para. 4.07), sensitivity testswere performed. These tests indicate that should the recovery be 70% of thebase case, the economic rate of return would be 67% and the present value ofthe net economic benefits would be $1.5 billion. Should the project incurcost overruns by 20%, the economic rate of return would be 79% and net presentvalue $2.3 billion; in the worst case, where the project is delayed by oneyear, incurs 20% cost overruns, and where the recovery is only 70% of theexpectation under the base case, the economic rate of return would be 58% andthe net present value of economic benefits $1.4 billion, indicating theattractiveness of the project even under pessimistic scenarios.

Other Benefits

6.06 The project will also benefit China in a number of ways. The use ofmodern equipment and laboratories, as well as the important training componentand other technical assistance will allow the transfer of petroleum technologyto China. It is estimated that, annually, about 500 professionals and 2,000skilled workers will receive advanced training under this project in allaspects of petroleum engineering and geophysics. These benefits are expectedto have a considerable induction effect throughout the country, as Daqing iscurrently one of the prominent centers for theorectical and practicaleducation in petroleum industry in China.

- 52 -

VII. RECOMMENDATIONS

7.01 Assurances were obtained from DPAB that:

(a) it would establish by March 31, 1983 and maintain a specialproject team headed by a Deputy Director in PCN1 (para. 4.12);

(b) it would maintain a separate project account (para. 3.14) andforward to the Bank a project progress report in an agreedformat at agreed intervals (para. 4.38);

(c) audited financial statements of the project accounts and of PCN1would be submitted to the Bank within six months after the endof each fiscal year (para. 3.19);

(d) it would review its current and future finances with the Bank byOctober 1 of each year (para. 5.18);

(e) it would undertake through qualified consultants a reservoirstudy for evolving the optimum plan for further development ofthe field, and review the findings and consequent impact on thedesign of the project with the Bank; the study will be completedby December 31, 1983 (para. 4.14);

(f) it would undertake through qualified consultants a four stagedfeasibility study on enhanced oil recovery for evolving theoptimum method of EOR; the findings at all stages of the studyand consequent action plan would be reviewed with the Bank(para. 4.15); the first three phases of the study will becompleted by December 31, 1983 and the pilot will be completedby December 31, 1985 (para. 4.15)

(g) it would undertake through qualified consultants a review ofprocess flow design and optimization of surface facilities, andreview the findings and agree on a consequent action plan withthe Bank; the study will be completed by July 31, 1983 (para.4.16);

(h) it would appoint qualified consultants to undertake a study ondrilling and completion practices for evolving a package offield practices consistent with the needs of Daqing and modernpetroleum technology and review the findings and agree on aconsequent action plan with the Bank; the study will becompleted by May 31, 1983 (para. 4.17);

(i) it would undertake through experts, a study on the detaileddesign of training curricula and teaching methods by January 31,1984, and review the findings and consequent action plan withthe Bank (para. 4.31);

(j) it would establish by October 1, 1983 two training centers, oneone for professionals and the other for skilled workers. (para.4.31);

- 53 -

(k) it would undertake through qualified consultants a study onsafety measures, review the findings and agree with the Bank aplan of action; the study will be completed by June 30, 1983(para. 4.37).

7.02 Conditions of disbursement would be:

(a) the first three stages of the study on EOR be completed and thefindings reviewed with the Bank prior to any disbursement forimplementation of the field pilot (para. 4.15); and

(b) the study on process flow design and optimization of surfacefacilities be completed and the findings reviewed and agreedupon with the Bank prior to any disbursement for the productionstations (para. 4.16).

7.03 A condition of effectiveness would be that a satisfactory onlendingarrangement be established between GOC and DPAB (para. 4.23).

7.04 Subject to the above conditions, the proposed project wouldconstitute a suitable basis for a Bank loan of $162.4 million to the People½sRepublic of China. The loan would be for a term of 20 years including a five-year grace period.

CHINADAQING OILFIELD DEVELOPMENT PROJECT

MINISTRY OF PETROLEUM INDUSTRYOrganization Chart

Refinfry Development Exploration D lln Planin eg F e Per.onenl1 nd C-rpo-tsoes under Scientific Rese.ech

Tehooy CdmInsr-mtioe-in

D 0 | onstructit o | | DFpartmcnt [ [ Departmcnt | | Dcpartmcnt | | Dcpartmenx ] | DEdpactamoent | 1 Petrolcum 1 PPctroro1lcP.urd- S.iwnfifi

I l l 4 I I l I Corporadon and Tcchnological~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~C,p t.nndTi~h.Igwi

| Tcsving Division j Division j | Divieion l Division Plan5tvntine Division o st Chi Division d. Chine Neone- In,,!,,,e

Detent OOS van College (Sichusel~~~C' O

. ian etroleumCollee 3 Chinc tl lifc R--h I-iit

6. Smiler5 PenrChieleamfl-

Collale

| TFshn.logy | | Administrativc | H Loggi~ ~~~~~~ng -' l Md Chin.a E- Chn ProdCctio | nd Payroll li prto Rmac Isi

J ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~~~ol Environcntal

[ t 1 H H I, Wd oil fild (nd., fldg .I MOPI/MOE utj.rWi.,ition)

I f- ~~~~~~~~2 E s China Pctrolcum

Surttlu _ Administration _ Shet gli oitfie d | | Daq ng Pctrolcum ] CollC.I Sh,,ngli)

0,if,.Id,~~~~~~~~~~~~ ~ 3. N.th-n P.,trolcum

-L COilfigId Ptoe 5Xi_an PerlemCollege| Administration | | Burea: 6. XiniCo g N-1

World Bank-23910

CHINADAQING OILFIELD GAOTAIZI RESERVOIR DEVELOPMENT PROJECT

Organization Chart

V-c P t dent

Chief Vi ie Peint Dii t Ved P-idtl Vice President c Ident OChief fOice ofAdministratiar an O P Conseructiontal Seroice Companies | PetrchemicaL | Engieer the eureau

ATrenportetice and Drilling and Capital Machlneey | Generell | noetmett |-

Marketing Exploration Construction Management Petrochemical _ Platele Traininge n ~~~Departmnent O epartment Decserrmeer Department Compaey Ofc

_ Labor aed Payroll Gealagy I n _ - S ia. earcDepartment Deperementrt-t C. 0f'.

Department Depanment ~ Oi Podten tiaul en Road Pacing |_|Communication|_an ei Ittu

[ Planning and | j Oil Prod-ctian ny

| Deparemene Department |_|DllnSeyc| Egierg | CoPy

_ .Dl Ser and vicr

oun n Oil Production | | eopltysical | | Oil Field Elcrit

_ Material _ Companien 171 E| plaromPany Coentracelan Sapply Company|Company C-;ompanydt

Company l 2 Seryicing l _f Drilling g dilIdog Material | Transportation|

Companes 12)1 Company Conpany

Doea Management | Automobile Repair|

D..W SDl. 7Dhier |

]~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~~~~~~.1 Bank--23907ny

- 56 - ANNEX 3.02

CHINADAQING OILFIELD GAOTAIZI RESERVOIR DEVELOPMENT PROJECT

DAQING PETROLEUM ADMINISTRATIVE BUREAUProduction Company No. 1

Organization Chart

Di-- o

Deputy Dire-tor for Deputy Director for Deputy Director for Chief Depufty Di-tor Administration Technical M-negement Oil Production E.gine-'oGeologisv for Gactaiti Prqject

DeOil Prodetin --- - -

H Finaxe _ Science and 1 Deper~.tment | | Research GaotaiziDepartment TeottoloelDermn WaterIntecienv lOotitOote Project UOnit

_ ODpartment _ Traiciog Depar.mettot

Oil Tranportaion

Technical Depar-tmn_ Personnel _ Plann~ing-ad Designn

Depatment oep-ar-met

Oil Prdoctic OilPoodofigo Ol Profuotio OilProdooioo Ol Prooofio Well Servicing ocrnic ohnr Taaotoo

_ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~~~~~~~~~~~~ogd Matirial

Station | | ~~~~~~~~~~~~~~~~~~~~~~~~~~~~Dispatching |

Dffice

0Oi1 Produrtlon | Oil Productigon r Oil Productiun | |Oil Ptoductiono Oil Production o Setvicirng Installation Protcts Truck rrl T2amsl(7j) Teamsl7) | l Teems(6 B) | Teeing(81 ) i Teams (61B Teamsl(11) | Teams(21) r Shop Teamsl 4j)

|Meintenance end |||Malotenoeceen Oo | Maintenance and |||MoiOteaoOnc aod |||Maintenanoe and ||| Preparation ||| Electricity ||| Overhaul Repairing[l Ropait Team Repair Tram j 1 Repair Team | l Repair Term | l Repair Team | l Team § 1 Team j 1 Shop j 1 Team

ma Wll Tectiog ll Logging Truock Truck Truck ||| Maintenance ||| Carpenter Welding |||Adminisratoive|Term Team | 1 Team Team | 1 Tram | l Team Torea Shop Units

Ll Well Samiciog | | Truck|lo WellTestong | | Well Teoting | | Well Totting Ttu Spciak | Eq hipomnt Re;pairinTeam Team Team Team l em lll Tram Team Shop

Adminiorrative |||Well Servicing |||Well Servicing |||Well Bombiing |||Well Semvicing |||Transportation |||Prefabrivotinon Material|1 Unit Team | l Teem | 1 Term | Team Team | 1 Tram | l Unit

Ll T | Lj ~~Administrativen t Adminstrativu|n Administretive o Administretiveo n Tool Repairing | j Material | |Aaministrativeoeem l l Unit l l Unit l l Unit l l ~~~~~Unit r Team | Warehoase|r Unit

0 Stetion | 10 ~EltRepirin t

Lj Technology | 2 Administrative|

…-- -Proposed under the project Adirutatv

-t-t ~ ~ ~ ~ ~ ~ ~ Wrl ak-30

- 57 -

CHINA ANNEX 3.03DAQING OILFIELD GAOTAIZI RESERVOIR DEVELOPMENT PROJECT

DAQING PETROLEUM ADMINISTRATIVE BUREAUDrilling Company No. 2

Organization Chart

| Director |

DeputY Director Deut Direfctonerr ::; Deputy Director|

A tmobl Productions I LS S C

Technical |§ Sft Education lH Dprmn

|Autormobile Equip-| Comprehensive ment Manoiement Science and Engery Services Investigation and

DeMagement Technology Department Study DepartmentDepartment

Asset Departmanning tPersonnelnDepartmnt rtment Department

Engineering Production Financet Engineering | 1 Prepartim n Department

Dispatching ManagementDepartment Department

Transportati6n Ilig Driling Brigade Cnstrlction Mn aterI Ssap,yBrigade Brigade No. 1 No. 2 Brigade Station

Transportation Drilling Teams Drilling Teams | ConstructidnTeam PlanningPreparationGrp

Maintenance Maintenance Maintenance Installation DispatchingStation Station Station Team Unit

Electrical ~~MaterialServieam j Service l Communication Unit

Material l J Materialn Boiler Warehouse| Station l l Station l | Workshop Keeping Group

HWMaintenance || Station

World Bank-23908

- 58 -

ANNEX 4.01

Page 1 of 4

CHINA

Daging Oilfield Gaotaizi Reservoir Development Project

Gaotaizi Reservoir Performance 1/and Expected Production Profile-

1. The reservoir oil has a viscosity of 9.2 cp and is undersaturatedby about 20 atmospheres. The oil formation volume factor is 1.116 reservoirvolumes pe,r stock-tank volume. The pour point of the stock-tank oil is about300 C. Special handling procedures will be required to keep the produced oilabove this temperature. It is also likely that reservoir cooling will occurnear water injection wells. This could require injecting relatively warmwater initially to displace mobile oil around the injection wells.

2. Parameters for picking net rock in the source document appearedreasonable if somewhat conservative. Net isopach maps were presented in thesource document from Zones G-1 through G-1V. These maps were planimeteredand average rock and fluid properties were used to verify the oil in placereported in the source document. The calculated oil in place was 171 MM m3compared to 159 MM m3 reported in the source document.

3. A water cut vs recovery curve presented in the source documentcan be matched using a Dykstra-Parsons type calculation, the approximateaverage properties of the 20 layers presented in the source document, anda high sweep conformance factor. The averaging of properties within 20layers in conjunction with the discontinous nature of the sands makes thisrecovery curve an optimistic prediction. It should probably be viewed asthe upper limit of what might be achieved in the reservoir.

4. In contrast to the above statements, the reported performance oftwo pilot water injection projects in the field has been very good. Althoughit is still early in the recovery life of these projects, the data availableindicate the pilots are performing better than would be predicted using thewater cut vs recovery curve that is considered to be optimistic.

5. Additional water cut vs recovery curves were developed in this studyusing the 20-layer data and less optimistic conformance estimates. Time-rate projections were made for three of these cases.

-/Excerpts from Bank Consultant review of Basic Data.

- 59 -ANNEX 4.01

Page 2 of 4

A time rate projection was presented as an illustration in the sourcedocument, and annual oil production rates were tabulated for the firsteight years of the projection. These projections were based on an invertednine-spot pattern, which does appear to be the best pattern for fieldwideprogram. The total reservoir scheme requires 615 producing wells and 206injection wells.

6. The overall injection scheme for the reservoir is consistent withthe nature of the rerservoir and the parameters presented in the sourcedocument. However, the time-rate performance presented for this scheme doesnot appear to be consistent with the basic engineering parameters presentedin the report. The time-rate performance indicates an oil rate of 3.8 MMtons per year will be maintained for 8 years after a development period.This rate is the maximum flowing capacity rate for the field based on an averagewell rate of 20.6 tons/day, 300 producing days per year, and 615 producing wells.Since water breakthrough is anticipated after only 2.5 percent of the oil inplace has been produced, this rate must decline. Even with pumping, it willnot be possible to maintain the plateau rate for 8 years. Using the pump per-formance curves shown in the source document, our calculations indicate theplateau rate will be maintained for only about 2 years.

7. In addition to the time-rate forecast for the base performance case,two additional cases were time rated. These cases incorporated lower confor-mance values that are thought to be better estimates for the total reservoir.Economic projections were made for all cases using the annual operating andinvestment costs from the source document. The results are as follows:

NetAreal Sweep Vertical Sweep Economic Oil Cash Net PV atEfficiency Efficiency Life Production Flow 10 Percent

Case Percent Percent Years 106 Ton 106 $ 106 $

Base 80 100 23 56.2 8451 3385

1 80 100 18 36.2 4832 2344

7 80 80 15 29.4 3894 2006

9 60 80 12 22.0 2828 1568

The Base Case is the source document case, and Case 1 is Core Lab's time-rate projection based on the same water cut vs recovery relationship. Ourforecast shows significantly less recoverable oil and consequently lessfavorable economics; however, all of the cases show positive cash flows andpositive present values at a discount rate of 10 percent per year. A realis-tic production profile (variation of case 7 above) is shown in the followingtable. All production forecasts presented in this report do not take intoaccount probable positive future response of the reservoir to enhanced recoverytechnology.

-60 - ANNEX 4.01

Page 3 of 4

Production Profile

Gaotaizi Reservoir

Calendar Crude Production Calender Crude ProductionYear '000 tons Year '000 tons

1983 171 1993 1,587

1984 1,122 1994 1,384

1985 2.074 1995 1,236

1986 3,025 1996 1,107

1987 3,800 1997 996

1988 3,542 1998 850

1989 2,989 1999 700

1990 2,472 2000 600

1991 2,085 2001 450

1992 1,790 2002 300

*

Most likely case

8. Careful monitoring of production and injection operations in thisreservoir is very important. A supervisory control system should be con-sidered in any planned monitoring system. The general features of such asystem are presented within the discussion section of this report. Surfaceinjection facilities should be designed to allow maintaining surface sepera-tion of the produced water and supply (makeup) water. A gas blanket should bemaintained in each water storage tank to prevent bacteria formation and tocontrol corrosion. The proposed surface production facilities for the Gaotaizireservoir are inefficient because recycling of produced fluids would be exces-sive, and the first-stage separation pressure would be too low. An alternateplan presented in this report should allow more efficient handling of productionfrom an engineering standpoint. Economic and engineering feasibility of theplan of operations cannot be compared in detail with any alternative plan dueto the lack of supporting data.

- 61 -ANNEX 4.01

Page 4 of 4

9. Every effort should be made to prevent formation damage indrilling, cementing, perforating, treating, production, and injectionoperations.

ANNEX 4.02- 62 -

CHINA

Daqing Oilfield Gaotaizi Reservoir Development Project

Detailed Project Costs

Yuan Million US MillionItem Local Foreign Total Local Foreign Total

1. Drilling

1.1 Pre-drilling preparation & winter protection 26.8 -- 26.8 14.9 -- 14.91.2 Drilling material and Freight 98.5 77.4 262.8 54.7 43.0 97.71.3 Completion material and services 25.1 14.4 39.5 13.9 8.0 21.91.4 Maintenance 6.8 -- 6.8 3.8 -- 3.81.5 Cementing and logging equipment and services 27.2 43.2 70.4 15.1 24.0 39.1

1.6 New rigs, drilling strings and equipment -- 23.4 23.4 -- 13.0 13.01.7 Wages and management 24.7 -- 24.7 13.7 -- 13.71.8 Utilities 13.3 -- 13.3 7.4 -- 7.4

2. Production

2.1 Workover rigs, fracturing trucks andproduction logging equipment 5.7 37.8 43.5 3.2 21.0 24.2

2.2 Oil well pumps and equipment 65.7 36.0 101.7 36.5 20.0 90.02.3 Metering stations 11.2 -- 11.2 6.2 -- 6.22.4 Pumping stations 31.9 -- 31.9 17.7 -- 17.72.5 Dehydration stations 7.2 -- 7.2 4.0 -- 4.02.6 Flow lines and oil trunk lines 39.4 -- 39.4 21.9 -- 21.92.7 Gas lines 20.3 -- 20.3 11.3 -- 11.32.8 Proto type station. 5.8 14.4 20.2 3.2 8.0 11.22.9 Gas processing 37.1 -- 37.1 20.6 -- 20.62.10 Gas compression 13.8 -- 13.8 7.7 -- 7.72.11 Water injection 25.7 -- 25.7 14.3 -- 14.3

3. Itilities and Infrastructure

3.1 Electric network 20.9 -- 20.9 11.6 -- 11.63.2 Roads 16.4 -- 16.4 9.1 -- 9.13.3 Buildings 23.4 -- 23.4 13.0 -- 13.0

3.4 Construction equipment and mobilization 15.8 -- 15.8 8.8 -- 8.8

4. Training Centers

4.1 Workers' center 7.3 3.1 10.4 4.1 1.7 5.84.2 Professionals' center 2.5 7.7 10.2 1.4 4.3 5.7

5. Laboratories 2.5 7.2 9.7 1.4 4.0 5.4

6. Computer(s) 4.9 25.2 30.1 2.7 14.0 16.7

7. Reservoir and EOR study and pilot 8.8 10.8 19.6 4.9 6.0 10.9

8. Technical assistance (studies for proto typestation, drilling and completion practices,

computer data base design, etc.) 0.5 5.4 5.9 0.3 3.0 3.3

9. Zhong Yuan

9.1 Seismic work for Zong Yuan 1.4 9.9 11.3 0.8 5.5 6.39.2 Technical assistance for Zong Yuan

and other projects 0.4 2.7 3.1 0.2 1.5 1.7

591.0 318.6 909.6 328.4 177.0 505.4

Physical contingencies 88.7 22.5 111.2 49.3 12.5 61.8

Price contingencies 122.8 65.7 188.5 68.2 36.5 104.7

Total Project Cost 802.5 406.8 1209.3 445.9 226.0 671.9

Front-End Fee -- 4.3 4.3 -- 2.4 2.4

Total Cost 802.5 411.1 1213.6 445.9 228.4 674.3

CHINADAQING OILFIELD GAOTAIZI RESERVOIR DEVELOPMENT PROJECT

Implementation Schedule

1982 1983 1984 1985

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

T - 7I -7 --- - I I I I I I I 7I IT I I iI I I IIIIIiIIIIIIIITG.otaizi Reservoir Development 150 Wells 400 Wells 821 Wells

Drilling

Oil and Gas Gathering

Water Flooding

Utilities and Infrastructure

Production Operations - - -

Import of Equipment ...........

Training

Buildings and Support Facilities

Curriculae Formulation and Revision ........

Import of Equipment and Material ....... ..

Training

Reservoir and EOR Studies

Reservoir Studies .....

EORF Feasibility and Lab Studies .......

EOR Pilot ...........

Laboratories

Ordering Equipment .......

Installation and Commissioning

Other Studies

Drilling and Production Practices ........

Production Proto-type Station ........

Safety .. .....

Others .......

Computer

Ordering of Equipment .....

Installation and Commissioning

Dongpu and Future Project

Dongpu Seismic . -

LPG Study ........

Studies for other Projacts

........... .Preparations of TORs or Tender Documents and Enaluating BidsWorld Bank-23919

- 64 - ANNEX 4.04

CHINA

Daqing Oilfield Gaotaizi Reservoir Development Project

Allocation of Bank Loan

Percent ofAllocation Total Item

Item Quantity Unit US$ Million F.E. Cost

1. Drilling

a. Portable drilling rigs complete 4 each 8.0 100b. Cementing trucks 4 each 6.0 100c. Cementing silos on trucks 6 each 3.0 100d. Drilling strings 6 each 2.5 100e. Blow out preventor, coiled tubing,

coring and formation testing equip-ment, tools, etc. lot 2.5 100

f. Formation logging trucks 3 each 4.0 100

2. Production and Surface Facilites

a. Workover-rigs on truck 10 each 4.0 100b. Hydraulic fracturing truck 4 each 5.0 100c. Production logging truck 6 each 12.0 100d. Submersible pumps 130 each 13.0 100e. Metering, instrumentation material &

equipment for process flow improvement - - 8.0 100

3. Training Center

a. Professionals' center 1 each 4.3 100b. Workers' center 1 each 1.7 100

4. Laboratories

a. Research labs. (RD1) 4 each 3.6 100b. Field labs (oil & gas eval.) 1 each 0.4 100

5. Seismic Equipment for two Parties - lot 7.0 100

6. Computer Center 1 each 14.0 100

7. Reservoir Study and EOR

a. Study - - 1.5 100b. EOR Pilot - - 4.5 100

8. Technical Assistance (Daging) - - 5.5 100

9. Zhong Yuan

a. Seismic equipment and processing - - 5.5 100b. Technical assistance (Zhong Yuan

and future projects) 1.5 100

10. Contingencies 34.0

11. Front-End Fee 2.4 100

Total Bank Loan 162.4

- 65 -

ANNEX 4.05

CHINA

Daging Oilfield Gaotaizi Reservoir Development Project

Disbursement Schedule of Bank Loan

Amount Disbursed CumulativeYear Quarter US$ Million US$ Million

1983 1

34 30 30

1984 1 30 602 30 903 20 1104 10 120

1985 1 10 1302 5 1353 5 1404 10 150

1986 1 5.4 155.42 3 158.43 4 162.4

- 66 -

ANNEX 4.06

Page 1 of 2

CHINA

Daging Oilfield Gaotaizi Reservoir Development Project

Notes on Training for Workers

and Professionalsl/

A. Workers' Training

1. The training center for Daqing should strive to provide the trainingneeded to assure that workers learn their particular jobs well, and perhaps thejobs of those with whom they work closely. This means training drilling crewpersonnel to do the various jobs on a drilling rig. The loggers and cementersshould be taught the information and procedures they will need to do loggingand cementing, including only the amount of science and mathematics needed toget the job done.

2. The training center for workers should be organized on the basis ofmany short courses - one to eight weeks - designed to meet specific objectives.A one-week course could cover the needs for refresher training of a workerfamiliar with fishing tools and techniques, while an eight-week course will benecessary to train a new production worker or welder. The training coursesrecommended for the period of field development (1983 - 85) are designed withthe idea of teaching workers how to work efficiently and safely in their jobs,how to properly care for the equipment with which they work or must maintain,and to learn something of the jobs of others working in adjacent areas, forexamples, those jobs to which they might be promoted, or whose duties theymight have to perform in an emergency.

3. It is not clear that the Technical High School and that part ofthe training center to be devoted to worker training will be one and the same.The sort of training needed for workers at Daqing does not call for three yearsof schooling. However, the three-year program will remain useful. A personcompleting its prepared program will be ready for a short course in instrumenta-tion or communications to prepare him for a position requiring considerable skilland knowledge of theory. On the other hand, a three-year course seems overskillfor the preparation of workover, production, and drilling crew personnel.

1 Excerpts from consultants reports (Mr. B. Whalen and Dr. H. Dunlap).

- 67 -

ANNEX 4.06

Page 2 of 2

4. The attached recommended training programs (Table 1) are intendedto cover the training needs for most workers during the three-year period ofintensive field development. The programs are also intended to be conductedat the Daqing training center, although there is no good reason they cannot beconducted at any location having satisfactory facilities. Some subjects arenot suggested as curricular items for the training center as they are notspecifically petroleum industry related. Such subjects include driver trainingfor trucks and tractors, diesel engineer mechanics and boiler men. Some ofthese trades should be touched on during courses that pertain to jobs thatinvolve them - boiler men on a drilling rig location, for example.

B. Professionals Training

5. The Petroleum Institute at Daqing which will house the facilities andsupply this faculty for professionals training is quite impressive. The curricu-lum for petroleum engineers is reasonable, the student teacher ratio is quitefavorable, the library contains few hundred thousands of volumes and one thousandjournals, half of them in foreign languages.

6. There is apparently little use being made of adult "refresher courses"for professionals (engineers, geologists and geophysicists) among Daqing operatingpeople. The training center's proposal for professional level refresher courseswill be a new concept for almost all of these people. The overall level of compe-tence at Daqing among the petroleum engineers needs improving, as indicated bythe operational practices followed (excessive mud weight, use of excessive pres-sure when cementing, failure to run a common SP log for depth correlation whenrunning a series of open hole well logs and performing drilling and completionoperations without the use of blow out preventors). Lack of any training inproject economics and project evaluation undoubtedly handicaps the engineers.

7. The training program proposed by Daqing Petroleum Bureau in Volume Vhas been considerably modified. The length of a semester has been cut from 6months to 3 months (to permit more people to be trained more rapidly), the numberof courses offered has been substantially increased, and the emphasis of thetraining has been shifted from research to operational problems. Also, the scopeof the training center activity has been broadened to accommodate the trainingneeds of geologists and geophysicists, as well as petroleum engineers (detailedprogram is shown in Table II). It is hoped that the facility will be largeenough to allow professionals to return for additional training about everythree years. (This would represent about 8% of their time devoted to training).Note that no courses are offered for drilling engineers on the understanding thatthese will be trained at the East China Petroleum Institute, at Shengli Oil Field,in Shang DongProvince.

8. Estimated cost for workers and professionals training is shown inTables III and IV.

- 68 - ANNEX 4.06

Table I

Page 1 of 3

Curricula for Worker's Training

A. BASIC TRAINING

(Training for inexperienced workers, or those entering a different fieldof work).

1. Drilling Crew

Length of course: 5 weeks: class size: 30Prerequisite: junior middle school certificate.

2. Production Workers

Length of course: 8 weeks: class size: 30Prerequisite: junior middle school certificate.

3. Well Servicing Workers

Length of course: 5 weeks: class size: 30Prerequisite: junior middle school certificate.

4. Logging Worker

Length of course: 3 weeks: class size: 10Prerequisite: junior middle school certificate.

5. Cementing Worker

Length of course: 3 weeks: class size: 15Prerequisite: junior middle school certificate.

6. Welder

Length of course: 3 weeks: class size: 12Prerequisite: junior middle school certificate.

7. Gathering and Pipeline Worker

Length of course: 3 weeks: class size: 20Prerequisite: junior middle school certificate or transfer from otherfield job.

B. ADVANCED TRAINING

(Training for experienced workers, or for those entering a specialized fieldsuch as instrumentation).

- 69 - ANNEX 4.06

Table I

Page 2 of 3

1. Drilling Technology

Length of course: 2 weeks: class size: 15Prerequisite: completion of basic course and 6 months of experience,or one year's experience.

2. Production Technology

Length of course: 3 weeks: class size: 25Prerequisite: 6 months experience, or 3 months with certificate forbasic production worker course.

3. Well Servicing Technology

Length of course: 3 weeks: class size: 15Prerequisite: 6 months experience, or 3 months experience andcertificate for basic well servicing worker course.

4. Advanced Logging Practices

Length of course: 2 weeks: class size: 10Prerequisite: 6 months experience or 3 months experience andcertificate for basic logging course.

5. Advanced Cementing Practices

Length of course: 2 weeks: class size: 10Prerequisite: 6 months experience or 3 months experience andcertificate for basic cementing course.

6. Advanced Welding

Length of course: 3 to 6 weeks: class size: 12Prerequisite: 6 months prior experience as welder, or certificatefrom basic course.

7. Well Testing Worker

Length of course: 2 weeks: class size: 10Prerequisite: 6 months experience inproduction, well servicing,or certificate for basic production workers course.

8. Electrician for Power Circuits

Length of course: 5 weeks: class size: 10Prerequisite: basic electrical courses from technical school; or 6months drilling rig experience with observed talent for electrical work,or understudy of rig electrician.

- 70 - ANNEX 4.06

Table I

Page 3 of 3

9. Instrumentation Worker

Length of course: 3 months: class size: 15Prerequisite: certificate from accredited school teaching basic scienceand mathematics; or 6 months understudy in instrument section doingrepair and maintenance of instruments.

10. Fracturing and Acidizing Worker

Length of course: 2 weeks: class size: 10Prerequisite: 6 months experience with downhole services teams.

- 71 -ANNEX 4.06

Table II

Page 1 of 2

Curricula for Professionals' Training(3 month semester, 3 hours/week in

class)

A. Petroleum Engineers

1. Geology and Geophysics for Petroleum Engineers

2. Open and cased hole logging

3. Production Logging

4. Computer programming and numerical methods

5. Operation of hand held and mini computers

6. Waterflood Technology with emphasis on Daqing problems

7. Production Technology I (Cementing, Perforating, Stimulating)

8. Production Technology II (Lifting, Separating, Metering, Gas Hydrates)

9. Production Technology III (Corrosion Control, Cathodic Protection,Coupon Testing, Inhibitors, Protective Coatings)

10. Production Technology IV (Reservoir Testing, Buildup and DrawdownTests, Productivity Index, Skin Factor, Equipment and Techniquesfor Pressure Testing)

11. Research Frontiers (Enhanced Oil Recovery (EOR); Complex Reservoirsimulation on computer)

12. Problems on Technical Management (Safety Engineering; EvaluatingPerformance; Motivating; Technical Planning and Scheduling)

13. Petroleum Economics and Project Evaluation (Time Value of Money,Discounted Cash Flow, Present Worth, Risk, Expected Present Worth)

14. Probability, Statistics and Error

15. Effective Communication in Chinese (Written and Oral)

16. English (Emphasis on Reading Technical English)

17. Seminar: Ten man study group meeting once a week to discuss a paperassigned by Professor.

- 72 - ANNEX 4.06

Table II

Page 2 of 2

B. Geologists and Geophysicists

1. Reservoir Engineering for Geologists and Geophysicists

2. Well Logging (open and cased hole)

3. Computer programming and numerical methods

4. Operation of hand held and mini-computers

5. Sedimentation and Stratigraphy at Daqing (Special reference tolacustrine and cyclical sedimentation)

6. Geologic history of Sungliao basin (tectonics, origin of sediments,depositional sequences, generation and migration of oil and gas)

7. Field work (examination of modern lacustrine and deltaic systems, andexamination of sources of Songliao Basin sediments exposed at basinmargins)

8. Stratigraphy seismology (use of seismic data to define lateral extentof reservoirs, detect lithologic changes, correlation of seismicdata with well logs)

9. Modern exploration techniques (satellite photos; 3D seismic computermapping, seismic hydrocarbon detection - bright spots and flat spots

10. Correlation by computer (auto correlation, cross correlation, othermathematical methods, multiple log correlations, applications ofgamma ray spectra log for correlations in shales; correlation usingdipmeter)

- 73 -

ANNEX 4.06

Table III

Page 1 of 2

Workerst Training Center

Cost Estimate

Cost In Units OfQuantity Item $1,000 U.S.

Technical Assistance and foreign advisors(lecturers and consultants) 950

- Text material for training 150

- Audiovisual materials (including projectors) 125

l Well pressure control simulator 75

1 Model of oil and gas gathering system 50

1 Model of natural gas plant 50

1 Pnematic control training simulator 50

1 Closed circuit television system, including: 502 cameras with microphones2 video recorder/players with 100 tapes10 color video monitors (25" diagonal or more)coaxial cable with connectors and impedancematching devices

Miscellaneous mud lab training items including: 551 water analysis kit; 8 Fann rotating viscosi-meters; 3 pH meters; 1 mud lubricity meter; 5single axle high speed mixers; 5 5-axle highspeed mixers; 10 mud testing kits; 6 retortsfor solids content testing; 5 electrical resis-tivity meters with cups; 2 rolling mud agingtesting device; 2 high temperature, high pres-sure tanks.

Miscellaneous tools, gauges, instruments 125

TOTAL 1,680

Note:

In addition to the above items the training center will need tobe equipped with domestically-made training materials, including, but notlimited to:

- a fully operational drilling rig representative of thosein common use in the field.

- 74 -ANNEX 4.06

Table IIIPage 2 of 2

- a workover rig

- a surface pumping unit (optional)

- electric welders

- switchgear, meters, transformers, etc. for electriciantraining

- various items of instrumentation gear

- mud funnels and balances for the mud lab.

75 -ANNEX 4.06

Table IV

Cost Estimate for Training Center ForPetroleum Engineers, Geologists & GeophysicistsExclusive of Capital Items such as Buildings

(In thousand US$)

Item/Calender Year 1982 1983 1984 1985 Total

Teaching Equipment 150 150 - - 300

Exp. Equipment forLabs + Demos. 200 200 - 400

Ref. Matl. + Texts(IncludingTranslation) 20 50 30 - 100

Spares & Supplies 75 75 75 75 300

Foreign Study ofTraining Methods 75 - 75 - 150

(6-10 men (6-10 menfor 6 wks) for 6 wks)

Teachers Advanced 50 84 116 - 250(3 men - (5 men - (7 men-4 mos) 4 mos) 4 mos)

Engineers AdvancedStudy Abroad 670 105 665 1,400

(10 men - (15 men - (10 men -

1 year) 1 year) 1 year)

Foreign Experts - 100 100 100 300Short courses at 4 courses 4 courses 4 coursesDaqing

Consultants Aid in 50 50 - - 100Course Design

TOTAL 620 1,379 1,446 845 4,290

VVery late 1982 or early 1983

ANNEX 4.07- 76 - Page I of 3

CHINA

Daqing Oilfield Gaotaizi Reservoir Development Project

Design of Computer Network1 /

Improved Petroleum Recovery Inc. (IPR) has been retained by the WorldBank to provide technical assistance to the Peoples Republic of China. Thepurpose of the mission to China and subsequent work which has bee conductedwas to survey existing computer facilities at Daqing and Dong-pu_2 oil fieldsto discuss and evaluate computer needs with relevant personnel, and to gatherinformation necessary to develop a suitable detabase for each field.Additionally, the mission included consultation with the Ministry of PetroleumIndustry, Daqing Bureau and the staff at Dong-pu on views concerning computerrequirements to provide support for petroleum exploration and production. Thefollowing recommendations for computer hardware and software acquisition andtraining of key technical personnel are being made as a result of site visitsand evaluation.

(i) The existing computer facilities are inadequate tohandlethe problems involvved in modern exploratin, reservoirengineering and reservoir management and the existingequipment is not compatible with technology computingrequirements and should be reassigned elsewhere.

(ii) A dedicated seismic processing facility for the Daqingprocessing facility should be purchased. All supportsoftware for the seismic package should be purchased toallow the staff at the Daqing Research Centre to work oncomplex reservoir modelling and control problems.

(iii) The computer facilities at Daqing should be arranged inanother processor network with two computers located at theresearch facility and two computers located at thesupervisory center.

(iv) The Research Center should contain two identicalprocessors, each of which should be augmented by an arrayprocessor to increase the effective computing capacity.

(v) The four processors in the Daqing network should beconnected in a local area computer network. The minimumtransfer rate on this network should be 50 K baud. Thiswill require special line treatment between the researchand supervisory centers if both remain at their present

-/ Summary of Bank consultant study.

Dong-pu is the old name of Zhong Yuan.

ANNEX 4.07Page 2 of 3

locations.

(vi) A single CPU system, of the same type used at the DaqingSupervisory Center, should be adequate for the internalcomputer installation at Dong-pu.

(vii) Every output device in the system should be capable ofproducing Chinese characters. This restricts line printeroutput to be of dot matrix type with plotting capability.

(viii) A universal terminal should be used so that volume purchasetechniques can be applied. A single terminal type improvesreconfiguration possibilities and simplifies maintenance.

(ix) Environmental control (air conditioning, humidity and dust)should be provided at each computer site - uninterruptiblepower supplies should be used to minimize computer downtime due to power fluctuations.

(x) The Daqing facility should keep an inventory of 95 percentspares and the staff should be trained to perform routinemaintenance functions. A service contract for majorrepairs should be obtained for all hardware (exceptterminals) for a five-year period after installation.

(xi) The operating system software for the Daqing network andthe Dong-pu network facility should be standardized.

(xii) Application software recommended for the computer systemsmust be capable of meeting the needs for sophisticatedfield, reservoir and geological studies. To meet theseneets, the following software packages are recommended:

(a) Database Management System.

(b) Graphics Software.

(c) Petroleum Engineering Applications Library.

(d) Numerical Simulations Models.

(e) General Engineering Program Library.

(f) Statistical/Mathmetical Library.

(g) Economic Evaluation Programs.

(h) Geological-Petrophysical Routines.

(i) Seismic Data Processing.

(xiii) The training of the engineering staff at Daqing and Dong-puin the use of the new computer equipment would be crucialto obtain maximum benefit from the computer system. An

- 78 - ANNEX 4.07Page 3 of 3

extensive testing and training program is recommended.

A full scale facility should be constructed in this country of originof the applcation software prior to shipment of equipment to the PeoplesRepublic of China. Training of hardware and software personnel should beconducted on this site with a small group of engineers selected from bothsites. Trained individuals should then be able to assist in morecomprehensive training efforts when the system is installed in China.

The importance of developing a knowledgeable staff cannot be over-emphasized. The hardware and software systems which have been recommended arevery modern and extremely powerful. If the system is not used to its capacityor is improperly managed due to inadequate training, the sophistication builtinto the system will not be realized. Figure 1 identifies the network layoutrecommended for Daqing and Dong-pu.

A detailed cost estimate for the system described above includingtraining and maintenance is provided in the body of this document. The totalfor this system (Daqing and Dong-pu) is 20.13 million U.S. dollars.

- 79 -

ANNEX 5.01

CHINADaqing Oilfield Gaotaizi Reservoir Development Project

Daqing Petroleum Administrative Bureau (DPAB)Income Statement 1978-80

(In Million US$)

Production 1978 1979 1980

Crude oil (million tons) 50.4 50.8 51.5

Sales

Crude oil (million tons) 48.4 49.6 49.6Natural gas (billion m ) 5.0 5.0 5.0

Price

Crude oil ($/tona 58.3 58.5 58.8Natural gas ($/m ) 0.03 0.03 0.03

Revenues

Crude oil 2,825 2,904 2,916Natural gas 15 15 14

Total Sales Revenues 2,840 2,919 2,'30Less: Sales tax (5%) 142 146 146

Net Sales Revenues 2,698 2,773 2,784

Expenses

Operating cost 384 562 663Depreciation 162 131 99Other Expenses 15 19 3

Total Expenses 561 712 765

Income before interest 2,137 2,061 2,019Interest - - 4

Net Income 2,137 2,061 2,015

Operating ratio 21% 26% 27%

- 80 -

ANNEX 5.02

CHINADaqing Oilfield Gaotaizi Reservoir Development Project

Daqing Petroleum Administrative Bureau (DPAB)Balance Sheet 1978-80

(In Million US$)

Assets 1978 1979 1980

Fixed Assets 1486 1854 2095Less: Accumulated Depreciation (738) (911) (998)

Net Fixed Assets 748 943 1,097

Current Assets

Inventories 202 277 269Accounts Receivable 21 9 15Prepaid Expenses 142 125 3Cash 26 5 2Others (special funds) 27 112 48

Total current assets 418 528 337

Total Assets 1166 1471 1434

Liabilities and Equity

Equity

Fixed Assets Funds 748 943 1097Working Capital Funds 84 238 116

Total equity 832 1181 1213

Current Liabilities

Bank Loan 174 76 78Due to Government 2 1 2Accounts Payable and receipts in

advance 9 53 40Others (special funds) 149 160 101

Total current liabilities 334 290 221

Total liabilities and equity 1166 1471 1434

Current Ratio (times) 1.3 1.8 1.5

- 81 -

ANNEX 5.03

CHINADaqing Ollfield Gaotaizi Reservoir Development Project

Daqing Petroleum Administrative Bureau (DPAB)Income Statement 1981-85

(In Million US$)

Production /a 1981 1982 1983 1984 1985

Crude Oil (million tons) 51.75 51.5 48.1 45.6 43.7

Sales

Crude Oil (million tons) 49.4 49.4 45.7 43.3 41.9Natural Gas (billion m ) 5.2 5.2 4.8 4.6 4.4

Price /b

Crude Oil ($/ton3 58.8 55.6 55.6 97.2 97.2Natural Gas ($/m ) 0.03 0.03 0.03 0.072 0.072

Revenues

Crude Oil 2905 2747 2541 4209 4073Natural Gas 15 15 14 33 32

Total Sales Revenues 2920 2762 2555 4242 4105Less: Sales Tax (5%) 146 138 128 212 205

Net Sales Revenues 2774 2624 2427 4030 3900

Expenses

Operating Cost 771 896 951 1002 1055Depreciation 66 88 106 114 114Other Expenses 19 19 19 19 19

Total Expenses 856 1003 1076 1135 1196

Income before Interest 1918 1621 1351 2895 2704Interest 4 7 16 19 20

Net Income 1914 1614 1335 2876 2684

Operating Ratio 31% 38% 44% 28% 31%

Source: DPAB and mission estimate.

/a Production after FY82 assumed to decline by 7% p.a.lb Foreign exchange rate at Y1.7 = US$1 in FY81 and Y1.8 = US$1 has been

projected for FY82 to 85. Price increase assumed to become effective inFY84.

- 82 - ANNEX 5.04CHINA

Daqing Oilfield Gaotaizi Reservoir Development ProjectDaqing Petroleum Administrative Bureau (DPAB)

Balance Sheet 1981-85(In Million US$)

Assets 1981 1982 1983 1984 1985

Fixed Assets/a 2647 3293 3981.0 4758 5050Less: Accumuated Depreciation (1064) (1152) (1258) (1372) (1486)

Net Fixed Assets 1583 2141 2723.0 3386 3564

Current Assets

Inventories 269 269 269 269 269Accounts Receivable 15 14 12 16 16Prepaid Expenses 3 3 3 3 3Cash 2 3 5 1 1Others (Special Funds) 48 48 48 48 48

Total Current Assets 337 337 337 337 337

Total Assets 1920 2478 3060 3723 3901

Liabilities and Equity

Equity

Fixed Assets Funds 1583 2141 2633 3251 3410Working Capital Funds 116 116 116 116 116

Total Equity 1699 2257 2749 3367 3526Long-Term Debt

IBRD Loan - - 90 135 154

Current Liabilities

Bank Loanb 78 78 78 78 78Due to Government 2 2 2 2 2Accounts Payable 40 40 40 40 40Others (Special Funds) 101 101 101 101 101

Total Current Liabilities 221 221 221 221 221

Total Liabilities & Equity 1920 2478 3060 3723 3901

Debt/Equity Ratio - - - 3/97 4/96 4/96

Current Ratio (times) 1.5 1.5 1.5 1.5 1.5

Source: DPAB and mission estimate

/a Capital construction and production accounts have been consolidated, andoverhaul expenditures have been excluded.People's Bank

- 83 -

ANNEX 5.05

CHINADaqing Oilfield Gaotaizi Reservoir Development Project

Daqing Petroleum Administrative Bureau (DPAB)Funds Flow Statement 1981-85

(In Million US$)

Sources 1981 1982 1983 1984 1985

Net Income Before Interest 1918 1621 1351 2895 2704

Add: Depreciation 66 88 106 114 114Overhaul Provision 80 139 142 134 129Oil field Uphold Provision 363 469 546 546 546

Internal Cash Generated BeforeContributions to Government 2427 2317 2145 3689 3493

Contributions to Government 1947 1658 1388 2933 2741

Internal Cash Retained 480 659 757 756 752

TBRD Loan - - 90 45 19Equity 166 123 - 129 158

Total Sources 646 782 847 930 929

Uses

Investment Program 642 775 831 911 909Debt Service - Interest 4 7 16 19 20Increases in Accounts Receivable - (1) (2) 4 (1)Increases in Cash - 1 2 (4) -

Total Uses 646 782 847 930 929

Source: DPAB and mission estimate.

CHINADAQING OILFIELD GAOTAIZI RESERVOIR DEVELOPMENT PROJECTFlow of Funds Between DPAB and GOC - FYs78 Through FY85

(In Million US$)

Actual Total Forecast TotalFY 78 79 80 78-80 81 82 83 84 85 81-85

TO: GOC

Net Income 2,137 2,061 2,015 6,213 1,914 1,614 1,335 2,876 2,684 10,423Depreciation (50%) 81 65 50 196 33 44 53 57 57 244

2,218 2,126 2,065 6,409 1,947 1,658 1,388 2,933 2,741 10,667co4.

FROM: GOC

Investment in DPAB 35 41 125 201 166 123 -- 129 158 576

Net Outflow from DPAB 2,183 2,085 1,940 6,208 1,781 1,535 1,388 2,804 2,583 10,091

TO: GOC

State Tax on Sales 142 146 146 434 146 138 128 212 205 829

Total Outflow to GOC 2,325 2,231 2,086 6,642 1,927 1,673 1,516 3,016 2,788 10,920

0%

CHINA

DAQING OILFIELD GAOTAIZI RESERVOIR DEVELOPMENT PROJECTDAQING PETROLEUM ADMINISTRATIVE BUREAU

Unit Cost of Production'($/ton)

Actual Projected

1978 1979 1980 1981 1982 1983 1984 1985

Materials 3.19 3.7 4.3 4.7 4.7 5.0 5.2 5.4

Wages 0.64 0.78 0.79 0.8 0.8 0.84 0.87 0.9

Depreciation 3.2 2.6 1.9 1.3 1.7 2.2 2.5 2.6

Overhaul 1.01 1.53 1.69 1.6 2.7 2.9 2.9 2.9

Electricity 0.67 0.75 0.85 0.9 0.9 0.94 0.97 1.0

Oil-field upholding 1.70 3.4 4.1 6.5 7.7 9.5 11.0 12.5

Others 0.73 1.06 1.65 0.74 0.98 0.99 1.45 2.04

Total 11.14 13.82 15.28 16.54 19.48 22.37 24.89 27.34

/a Adjusted to exclude intercompany transaction.

>4Un

CoJ

CHINAriAOTNi OIl.TlF (.D GIAOTA17T RFSFRVOTR )FVF'.OFPMFNT PROJECT

ECONONMIC ANAl.YSTS(IN MTI tTON OF DECEMBER 1981 lS (5 0l0 ARS)

SHADOW F'RICE.D

1982 1983 1984 1985 1986 1987 1988 1989 1990

PRODIJCT ION__________

CRUDrE OIL (000 TONS) - 171.00 1,122.00 2,074,00 39025.00 3,800.00 39542.00 2,989.00 2,472,00GAS (MNIlATON CU H) - 7.33 48.09 88.89 1?9.64 162.86 1J5 1.80 128.t0 105.94

VALUIE

CRUDE OIL ($/TON) 00.(0O 206.00 212.18 218.99 229.11 ?31.86 ?38.82 245.98 253.36VALI.JF OF GAS ($/CU H) 0.28 0.29 0.30 0.31 0.32 0.33 0.34 0.35 0.36

BENEFITS

CRUDE OIL - 39F.23 238.07 4'53.27 680.96 881.07 84'.90 739.23 626.31GAS - 2.13 14.43 27.'56 41.448 53.74 51.61 44.84 38.14

TOTAI.. BENFFTTS - 37.36 292.50 480.83 722.44 934.81 897.'1 780.07 664.45

00

COSTS

CAPITAL INVFSTMFNTS 116.90 209.70 139.40 24.60 - - - - -OPERATING COSTS - 3.40 9.'60 21.30 ;9.20 57.80 64.20 69.10 77.70

TOTAI.. COSTS 116t 90 21.3.10 14',00 4'9-90 ;?9.20 57.80 64.20 69.10 77.70

NFT BENFFTTS (116,90) (175.74) 107.50 434.93 683.24 877.01 833.31. 71.0.97 586.75

NET PRFSENT VAlIJE

ACCUJMUJLATFD NET PRFSFNT VAIlIF AT 1.2% (104.38) (244.48) (167 96) 108.45 496h. 4 940.46 1,317.41 1,604,56 1,886.15

RETURN ON TNVFSTMFNT - 90.881%

CHT 14ADAQTNr Oft F(FID GAOTAIT7 RFSFRVOTR rfFVFnOPHFNT PROJECT

ECONOMIC ANAl.YS7S

(INMTIl. T(ION OF DFCFMFR 198t tlS DOLLARS)SHADOW F'RTCFT

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

PRODLICTION

CRUDE OIL (000 TONS) 2,085.00 1,790.00 1,587.00 1,384.00 1,236.00 1,1O7.00 996.00 850.00 700.00 600.00 450,00GAS (MILLION Ctl M) 89.36 76.71 68.01 'i9.31 52.97 47.44 42.69 36.43 30.00 25.71 19.29

VALUE

CRUDE OIL (S/TON) 255.89 258.45 261.0:3 263.64 266.28 268.94 271.63 274.35 277.09 279.86 282.66VALUE OF GAS ($/CU M) 0.36 0.36 0.36 0.36 0.36 0.36 0.36 0.36 0.36 0.36 0.36

BENEFITS

CRUDE OIL 533.53 462.63 414252 364.88 329.12 297.72 270.54 233.20 193.96 167.92 127.20 OGAS 32.17 27 .2 24.48 21.3'i 19.07 17.08 15.37 13.11 10.80 9.26 6.94

TOTAL BENEFITS 564.70 490.25 438.73 386.23 348.19 314.80 289.91 246.31 204.76 177.18 134.14

COSTS

CAPITAL INVESTMFNTS - - - - - - - - -OPERATING COSTS 80.90 83.50 8i,40 87.96 90.60 93.32 96.12 99.00 101.97 105.03 108.18

TOTAL COSTS 80.90 83.90 8!.40 87.96 90.60 93.32 96.12 99.00 101.97 105.03 108.18

NET BENEFITS 484.80 406.79 393.33 298.27 257.59 221.48 189.79 147.31 102.79 72.15 25.96

NET PRESENT VALUE

o H

ACCUMULATED NET PRESENT VAlUE AT 12% 1,972.24 2,089.17 2,179.86 2,248.22 2,300.93 2.34l,39 2,372,39 2.393,80 2,407,17 2,415. i52,418,24

- 88 -ANNEX 7.01

CHINA

Daging Oilfield Gaotaizi Reservoir Development Project

Related Documents and Data Available in the Project File

- Development Project for the Gaotaizi Oil Reservoir (DAB 1981).

- Review of the Development Project for the Gaotaizi Oil Reservoir (CoreLaboratories, Inc., December 1981).

- Plan for the Development and Construction of the Gaotaizi Oil Reservoirin the Central Areas of Sae'rtu Oil Field (DAB, January 1982).

- Report on the Evaluation of the Skills of Workers and Their TrainingNeeds, Daqing Oilfield, PRC (B.R. Whalen, April 1982).

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