Framework of policies, institutions in place to enable China to meet its soaring oil, gas demand

China's energy challenge—1

This is the first of two parts; the second part will appear Sept. 13.

Portions of this article first appeared in China Law & Practice, February 2004, 18(1), pp. 19-27 and is reproduced with the permission of Euromoney (Jersey) Publications (Jersey) Ltd.

For China, the energy challenge is clear but formidable: It must find additional sources of energy, both domestic and foreign, to fuel its growing economy.

China now accounts for more than 10% of the world's energy consumption, second only to the US. The country has been a net importer of oil since 1993.

According to the International Energy Agency, by 2030, China will need to import up to 85% of its crude oil requirements and 50% of its natural gas.

IEA estimates that $2.3 trillion will need to be invested in China's energy infrastructure over the next 25 years to satisfy demand. Of this amount, domestic investment in the search for oil is estimated at $119 billion and just under $100 billion investment for gas infrastructure, much of this for distribution networks.

Through government reform and reorganization and the promulgation of laws and regulations, China has put in place the legal structure and institutions required to meet the energy challenge. Additional changes can be expected in the near future as China continues to restructure the energy sector and its regulatory regime to satisfy its accession obligations to the World Trade Organization.

China's energy plan

The "big picture" of the government's energy sector strategy is embodied in the government's national economic plans, or 5-year plans (FYP).

The tenth and current FYP for 2001-05 emphasizes the diversification of China's energy infrastructure, but with a focus on oil and gas. While acknowledging that coal will remain China's dominant fuel for the foreseeable future, the plan advances oil to a place of "strategic importance." Natural gas is given "developmental priority," with plans for new pipelines and LNG import facilities. The Tenth FYP calls for accelerating China's domestic exploration and production and accessing overseas resources. It also emphasizes energy conservation and acknowledges the need to ensure sustainable energy development.

The Tenth FYP continues to stress improving China's electric power generation and transmission infrastructure, including hydroelectric and nuclear power, and developing renewable energy sources with the ultimate goal of reducing reliance on coal.

The following comprises the Tenth FYP's key oil and gas priorities:

• Domestic exploration and production. Generally, the Tenth FYP's goal is to stabilize oil production in the East, develop the northwestern basins, and continue to pursue offshore opportunities. The northwestern basins are seen as a "strategic transition" for the oil industry, away from reliance on traditional fields in the northeast (including Daqing, China's oldest and largest oil and gas field). Among the major basins (Tarim, Turpan-Hami, and Junggar) in Xinjiang in the northwest, Tarim is thought to be the most promising (although results to date have not matched this optimism). A network of pipe- lines, generally from west to east, is planned to transport production from the remote northwestern basins.
• Natural gas. It is projected that gas will account for 7% or more of China's total energy consumption by 2010, nearly doubling its current role. The Tenth FYP encourages gas imports, LNG terminal facilities, and pipeline construction. It specifically highlights gas transport through the West-East Pipe- line, the Guangdong LNG import terminal project, and pipelines from Chongqing to Wuhan and from Xining to Lanzhou.
• Strategic reserves. To promote national energy security, the government is expected to fund or assist in funding construction of several oil reserves storage facilities during the next 5 years. The government already has selected four locations (out of a dozen ultimately planned). Design and construction of the storage facilities will be entrusted to the three national oil companies, but the stockpile eventually will be put under the direct jurisdiction of the government and administered independently of commercial stockpiles held by the national oil companies.
• Foreign investment in China. Whether in oil or gas, onshore or offshore, an unmistakable theme of the Tenth FYP is the encouragement of greater participation by foreign investors.
• National oil company investment abroad. To supplement domestic production, the Tenth FYP mandates an expansion by China's national oil companies in exploration and development activities in three strategic regions: Russia/Central Asia, Middle East/North Africa, and South America. Certain countries, including Russia, Kazakhstan, Turkmenistan, Iran, Iraq, Sudan, Venezuela, and Indonesia, are emphasized. The Angarsk (Russia)-Daqing oil pipeline, for example, is a priority project. Pursuing oil and gas development on domestic and international fronts in tandem is often referred to as the "Two Resources, Two Markets" strategy.

China's institutions

No ministry or government agency is charged exclusively with oversight of the oil and gas industry, although several national governmental bodies have overarching jurisdiction across the industry.

Some are portfolio ministries that oversee their respective specialty areas, while a national economic management commission also exists to oversee and coordinate different sectors of the economy.

These institutions include:

National Development and Reform Commission. NDRC combines functions handled in the past by the former State Planning (and Development) Commission, the former State Economic and Trade Commissions, and certain other entities. It oversees and manages China's national economy, including setting production targets and pricing for the energy sector. The Energy Bureau within NDRC focuses on development and utilization of energy resources, both domestic and foreign. Within the bureau, the National Oil Reserve Office will manage the strategic reserve program. Overall, NDRC will be influential in shaping the foreign investment regime within China's domestic energy sector as well as in setting the pace for China's oil and gas ventures abroad. In addition, NDRC must approve feasibility studies for oil and gas exploration, development, and production, whether onshore or offshore, that involve foreign partners.

• Ministry of Commerce. Mofcom is another major institution, formed in 2003, to consolidate the oversight of China's domestic economy and foreign economic relations that were previously handled by separate agencies, among which included the Ministry of Foreign Trade and Economic Cooperation and the State Economic and Trade Commission. Mofcom's functions include managing and regulating international economic and trade relations, WTO compliance, and foreign investment in China. Mofcom approves production-sharing contracts (PSCs) and other joint-venture arrangements with foreign enterprises; it also publishes the Foreign Investment Guidance Catalog jointly with the NRDC.
• The Foreign Investment Administration within Mofcom drafts plans, policies, laws, and regulations relating to foreign investment and is responsible for their implementation and enforcement. Two divisions within the FIA coordinate and guide the approval, filing, and administration of energy projects that involve foreign capital. The Service Trade Division covers exploration and production for oil and gas as well as public utilities and pipeline network projects. The Manufacturing Industry Division has jurisdiction over refineries, petrochemical, chemicals, metallurgy, power stations, and related energy areas.
• Ministry of Land and Resources. Molar has broad responsibility for the planning, administration, protection, and utilization of China's natural resources. In the oil and gas industry, the influence of its authority is mostly felt in the upstream area. Under the PRC (People's Republic of China) Mineral Resources Law, Molar designates blocks for exploration, approves geological reserve reports, grants licenses for independent and foreign oil and gas activities, and administers the registration and assignment of exploration and production licenses.
• State Administration of Industry and Commerce. SAIC is in charge of ensuring that all individuals and entities engaging in business activities are in compliance with registration requirements. In this regard, the SAIC (or its local administrations) grants business licenses to officially enable foreign investment entities in China's oil and gas sector to go into business operations.
• State Asset Supervisory and Administration Commission. This ministry-level commission supervises assets and charts the reform and restructuring of all centrally owned enterprises, other than those in the financial services industries. Its role includes establishing standards for capital preservation and appreciation and for corporate governance and administration. It also appoints senior personnel of centrally owned enterprises. State ownership of the national oil companies renders this agency's role of key importance to the oil and gas industry.
• State Environmental Protection Administration. Under the PRC Environmental Protection Law, SEPA regulates all oil and gas activities upstream (onshore or offshore) and downstream, including the installation or renovation of facilities and the discharge of pollutants. An environmental impact report must be prepared for any new or renovated installations. These projects must await environmental certification and the granting of any pollutant discharge permits that are required before construction can begin.

National oil companies

There are today four national oil companies (NOCs) in China. China National Petroleum Co. (CNPC), China Petrochemical Corp., and China National Offshore Oil Corp. (CNOOC) have publicly owned subsidiaries through which most operations are conducted, while Sinochem continues to be exclusively a state enterprise.

CNPC's PetroChina and China Petrochemical's Sinopec Corp. are today the dominant onshore operating companies in China, ranking first and second, respectively in oil and gas production. Generally, PetroChina operates in the north, northeast, and west of the country, and Sinopec in the east and southeast. Historically, CNPC had its main business in E&P, while China Petrochemical focused on refining and other downstream businesses. By government directives, which included an exchange of assets, both companies were reorganized in 1998 into vertically integrated companies, each with responsibility for exploration, development, production, refining, and marketing in their respective regions. A key purpose of the restructuring was to prepare the companies for their initial public offerings.

A capsule description of each NOC follows:

• PetroChina, in addition to its upstream functions, operates China's largest pipeline network, including natural gas, crude oil, and refined products pipelines. The company also is the sponsor of the 4,000 km West-East pipeline from Xinjiang to Shanghai. PetroChina's international interests are concentrated in Southeast Asia (although its main shareholder, CNPC, holds assets throughout the world).
• Sinopec is still the largest refiner and seller of refined products in China. The company's upstream operations provided about a quarter of its refineries' feedstock in 2003, while more than half was imported oil. Sinopec recently won the right to develop gas in the northern part of the Rub' al-Khali desert region in Saudi Arabia. There are also reports that Sinopec recently purchased interests in three blocks in the Caspian Sea region of Kazakhstan and is in final stages of negotiation for certain assets in Azerbaijan. In addition, Sinopec is conducting exploration activities in Iran's Kashan area and has submitted bids for the right to develop another 16 oil fields in Iran. Sinopec's subsidiaries also provide contract drilling services in Ecuador and Qatar.
• CNOOC Ltd., the listed arm of CNOOC, is China's principal offshore operator, with international assets and growing downstream operations. Along with Sinopec National Star Corp. (SNSC), CNOOC has responsibility for petroleum activities in territorial waters off China at depths greater than 5 m. The company shares responsibility for operations in shallow waters (less than 5 m) with the other three major players: PetroChina, Sinopec, and SNSC. Like its sister companies, CNOOC Ltd. conducts operations both independently and with foreign partners. Its largest producing area is in Bohai Bay, followed by the western South China Sea. CNOOC is also involved in several LNG projects, natural gas pipelines, and supply development projects along the eastern coast of China, as well as the country's largest petrochemical complex in Nanhai. The company's international assets are largely in the Pacific Rim and involve foreign partners.
• Sinochem, the fourth NOC, is a relative newcomer to the operational side of the industry, having assumed responsibility for exploration and production activities as part of its 2002 restructuring. Historically, Sinochem has been an export and import company for crude oil and petroleum products. Its prominence in this area continues today, in addition to major interests in oil transportation, terminals, and storage, as well as the transportation and distribution of petrochemicals through a joint venture, the Shanghai Orient Terminal Co. Sinochem's upstream activities are currently limited to its oil and gas assets in Tunisia, Oman, and the UAE.

Legal regime

China has put in place the legal structure and institutions, including a foreign investment regulatory regime, to meet China's energy challenge.

As China continues adapting to its WTO accession obligations, further changes in some areas can be expected in the near future.

We'll cover the most notable of the changes, including those yet to come, in Part 2 of this article next week.

We'll also provide an overview of the regulatory regime that foreign investors must navigate to do business there while competing with China's NOCs for energy resources around the world.

The authors