For decades the midstream oil and gas sector in China has been controlled by three national oil companies as an internal part of their integrated oil and gas business. This has left no room for other investors in the sector, either under law or in practice. However, this long-closed sector is now being opened as a result of a series of legislative and policy changes.
As of 2014, China has built around 100,000 kilometres of oil and gas pipelines, including 60,000 kilometres of gas pipelines. Three major national oil companies hold the vast majority of long-distance gas pipelines: CNPC (85%), Sinopec (8%) and CNOOC (5%). The transmission, production and sale of oil and gas in China are synergistically managed by these three companies.
With the growing diversification of upstream and downstream players and the rapid development of pipeline networks, demand for reform in China's oil and gas midstream sector is increasing. In response to this demand, the authorities are actively adopting various measures to change the existing situation in an attempt to liberalise the midstream sector.
On February 13 2014 the National Energy Administration (NEA) published its Supervision Measures on Fair Access to Oil and Gas Pipeline Network Facilities (for Trial Implementation). One of the highlights of these access rules is a requirement that pipeline network operators provide their surplus service capability (if any) to upstream and downstream market players as well as midstream competitors on a fair and non-discriminatory basis. The access rules clarify for the first time that unconventional gas (eg, coal-based natural gas, coal-bed methane and shale gas) falls within the service scope of pipeline networks. This has been recognised as a significant step forward, marking a prelude to wider market access to the oil and gas industry.
Soon after the promulgation of the access rules, a more comprehensive regulation was issued on February 28 2014: the National Development and Reform Commission (the NDRC), one of the most powerful ministries in China, promulgated its Administrative Measures on the Construction and Operation of Natural Gas Infrastructure, which came into effect on April 1 2014. These infrastructure rules regulate the planning, construction, operation and services of gas infrastructure (both onshore and offshore), gas operation adjustments, emergencies and security, among other things. However, gas facilities for urban residents are not covered by these rules. According to the infrastructure rules, 'gas infrastructure' refers to transmission pipelines, storage facilities, liquefied natural gas terminals, liquidation facilities, compression facilities for gas and relevant ancillary facilities. The NDRC and the NEA are jointly designated as the primary enforcers of this regulation.
The infrastructure rules provide access for "social capital" to gas infrastructure – including pipeline networks and liquefied natural gas terminals – but do not clarify whether 'social capital' includes foreign investment. Presumably, this should include foreign investment because the 2015 Catalogue of Sectors for Guidance of Foreign Investment lists the "construction and operation of oil and gas pipelines and oil and gas storage" as an "encouraged" category for foreign investment. The infrastructure rules welcome various capital sources for investment and participation in the construction of gas infrastructure, subject to the national and municipal plan. The rules also provide exit procedures. Given the public welfare considerations in gas infrastructure, operators in this area are not allowed to exit without advance notice. If certain gas infrastructure must be terminated permanently, the operator should inform the relevant regulators, suppliers and customers one year in advance.
As for the operation of gas infrastructure, considering that the pipeline business constitutes a natural monopoly, the infrastructure rules provide for strong supervision over operators in this area. For instance, operators are required to disclose publicly the conditions and procedure for obtaining their services as well as their surplus service capacity. They should provide surplus services to all users on a fair basis and are prohibited from bullying other gas enterprises by refusing to provide services or imposing unreasonable conditions on the provision of their services. In addition, operators are required to maintain transparency in their pipeline business to ensure the accuracy of their cost and revenue figures.
However, one question remains: will a gas infrastructure operator have the right to sell gas as it provides carrier services – that is, by engaging in bundled businesses? The answer is unclear under the existing laws and regulations.
Uncertainty also exists with respect to effective market entrance after promulgation of the infrastructure rules. Investment in gas infrastructure incurs a high level of risk due to the lack of market-oriented pricing mechanisms and the vulnerability of new entrants to the strong market power of the national oil companies (especially CNPC and Sinopec). New capital investment in this sector is likely to suffer from insecure gas supply and other forms of oppression by the three national oil companies in the upstream sector.
Although market access to midstream facilities has been opened to social capital under the infrastructure rules, investors and operators must also acquire government concession rights to run their facilities and the government is obliged to supervise and regulate such natural monopoly-related businesses accordingly. It is against this backdrop that the Ministry of Finance and other relevant regulators have put forward the concept of public-private partnership (PPP) as a solution.
On April 27 2015 the NDRC, along with five other ministries, issued the Administrative Measures on Government Concession Rights for Infrastructure and Public Utilities, which apply to energy-related infrastructure. These concession rules entered into force on June 1 2015.
As a way to structure PPP projects, according to the concession rules, social capital investors and operators (both domestic and foreign) are encouraged to enter into concession agreements with the relevant government body for the construction and operation of infrastructure or public utilities in sectors such as energy, transportation, hydraulic engineering, environmental protection and municipal public engineering. The PPP project can be realised under various models, such as build-operate-transfer (BOT), build-own-operate-transfer and build-transfer-operate. The concession rules regulate the establishment, operation and supervision of PPP projects, conclusion and performance of PPP contracts and dispute resolution. In short, these rules fill the gap left by the infrastructure rules and provide social capital investors and operators with a more specific and practical model for participation in infrastructure projects.
The concession rules emphasise the protection of and support for social capital investors and operators. For instance, they require full performance of the contract by the government party. The concession rules specifically prohibit the government party from breaching the agreement on the pretext of changes in the administrative region division, government leadership, department responsibility or person in charge – all of which have been widely used in practice by the government as excuses for ceasing to perform. Moreover, the concession rules provide that the government party should indemnify the loss of the citizen party in case of breach, and should pay compensation if the contractual projected interests of the citizen party are damaged as a result of changes in laws, regulations or policies.
One critical question that arises is whether the PPP contract should be considered a contract signed between two equal persons – so that the parties may claim for loss and damages under civil law (eg, the General Rules of Civil Law and Contract Law) as remedies – or as a specific administrative act by the government body to grant concession rights only with the appearance of a contract, in which case the entity granted such concession right may resort only to administrative procedures (eg, filing a complaint, applying for administrative reconsideration and bringing administrative litigation) should its rights and interests be violated. According to the Administrative Litigation Law (as revised, effective on May 1 2015), all disputes arising from government concession agreements fall within the jurisdiction of an administrative court.(1) As for the applicable laws, the Supreme People's Court stipulated in its judicial interpretation of the Administrative Litigation Law (as revised) that civil laws should apply if they do not violate the compulsory provisions of the administrative laws and the Administrative Litigation Law.(2) What this effectively means is that the application of civil laws and contract laws should be subject to the compulsory provisions of the administrative laws and the Administrative Litigation Law. This judicial interpretation, if extended to apply to PPP projects, will weaken the protection for investors in PPP projects, as this will increase uncertainty risks for PPP project contracts.
As for dispute resolution, the concession rules provide for mediation by a third-party expert or institution, administrative complaints, reconsideration and litigation. Before the revised Administrative Litigation Law entered into force, a large number of disputes were also resolved through civil court proceedings.
Notably, the concession rules do not specially mention that disputes arising from PPP projects can be resolved through arbitration. It has been said that further rules are needed to clarify that arbitration is an acceptable way of resolving disputes under PPP projects; but in reality, many cases can be found in which parties to BOT projects agreed to arbitration as the dispute resolution mechanism well before the concession rules were promulgated. Moreover, several widely used PPP contract templates contain arbitration clauses. For instance, the NEA published a standard contract for gas purchase agreements on February 25 2014,(3) which contains a complete arbitration clause. It is reasonable that the NDRC, the Ministry of Finance and other ministries should allow arbitration as a means of dispute resolution for PPP projects.
In sum, the abovementioned legislation – along with other relevant regulations and rules – has created a comprehensive and solid legal framework for social capital investors and operators other than the three national oil companies to participate in the midstream oil and gas business. These efforts have demonstrated the determination of the Chinese authorities to reform the gas industry and create a more open, fair and competitive market. However, further and more detailed rules are still needed to ensure the liberalisation of market access to the midstream oil and gas sector. As such, a new wave of investment in energy-related infrastructure projects is likely, bringing in more capital and experienced operators from both China and abroad.
For further information on this topic please contact Libin Zhang or Mengzhao Lu at Broad & Bright by telephone (+86 10 8513 1818) or email (firstname.lastname@example.org or email@example.com). The Broad & Bright website can be accessed at www.broadbright.com.
(1) See Article 12(11) of the Administrative Litigation Law, which states:
"The people's court shall accept the following claim lodged by any citizen, legal entity or any other organisations:… (11) believing an administrative body failed to perform in accordance with the laws or the contractual agreement, or change or revoke illegally government concession agreement, land and housing expropriation and compensation agreement or any other agreement of this kind."
(2) See Article 14 of the Interpretations of the Supreme People's Court on Certain Issues Concerning the Application of the Administrative Litigation Law, which states:
"When the people's court reviews whether or not an administrative authority has performed an agreement according to law or as agreed or its unilateral change or termination of agreement is legal, the court may, in addition to application of the administrative laws, apply the provisions of civil laws that are not in violation of the compulsory provisions of the administrative laws and the Administrative Litigation Law."
(3) Available (in Chinese) at http://zfxxgk.nea.gov.cn/auto92/201403/t20140304_1777.htm.
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