Introduction

On May 21 2017 the Communist Party Central Committee and the State Council issued the Opinions on Deepening the Reform of the Petroleum and Natural Gas Sector, which expanded the oil and gas sector reform's:

  • guidelines,
  • basic principles,
  • general aim and
  • key tasks to be performed.

The existing phase of the oil and gas reform started after the third plenary session of the 18th Central Committee in 2013, during which the reformation of the oil and natural gas sector was proposed. Over the next two years, the Chinese authorities introduced a series of policies to promote reform of the oil and gas sector.

Tasks

The opinions outline eight tasks which emphasise that the market should play a decisive role in resource allocation and that the government should improve its role in this regard.

The opinions cover the entire oil and gas industrial chain, including:

  • the commencement of exploration and exploitation;
  • oil and gas import management;
  • refinement;
  • pipelines;
  • product pricing mechanisms;
  • state-owned company reform;
  • storage; and
  • environmental and safety management.

Motivation behind reform

The planned reform overshadows the prior reform in light of the urgency created by:

  • the dwindling oil and gas supply, which is crucial to national security;
  • the fact that the oil and gas industry is largely monopolised by state-owned companies, which has led to a lack of competitiveness in the international market; and
  • the aim to rebuild the industrial chain and complete the institutional reform.

Key points

Oil and gas exploration and exploitation in the upstream sector is the foundation of the oil and gas industry. Further, the upstream sector is the most capital intensive and lucrative, making it the most difficult part of the reform.

In the midstream sector, the independence of pipelines and the release of import rights are the key issues.

The reform of the downstream sector is under great pressure, but the completion of the pricing mechanism and introduction of mixed ownership may be breakthrough achievements.

Upstream sector

In the upstream sector, there have been many prior attempts to reform mineral rights. However, the desired result of "gradually building an exploration and exploitation system which is led by large state-owned oil and gas companies and jointly participated in by various organs" has not been achieved. According to the opinions, the reform encourages competition in upstream exploration and development by issuing tenders for blocks and strengthening the terms and conditions that a company must fulfil in order to retain a block. The government will allow eligible companies to apply for licences to develop conventional projects which used to be dominated by state-owned companies.

At present, China's oil and gas sector – especially exploration and exploitation rights – are dominated by four state-owned heavyweights:

  • the China National Petroleum Corp (CNPC);
  • the China Petrochemical Corp (Sinopec);
  • the China National Offshore Oil Corp (CNOOC); and
  • Shaanxi Yanchang Petroleum Co Ltd.

The opinions aim to correct further the long-accused monopoly of oil and gas resources, which has resulted in employee redundancies and inefficient resource allocation.

In 2015 the government experimented with public bid offers for some oil and gas blocks in the western Xinjiang Uygur autonomous region, which attracted several private companies. The entry threshold remains high, as the most promising blocks and resources are still controlled by the oil and gas heavyweights. With the limitations of technology and exit mechanisms, private companies have much to do in this sector.

It is generally agreed that the overall oil and gas system reform will improve the upstream sector by:

  • opening up the mineral rights market by changing the registration system to a bidding system;
  • relaxing the restrictions regarding the development qualifications of exploration and exploitation;
  • increasing holding costs and strictly controlling the exit mechanism of exploration rights; and
  • establishing a mineral rights transfer system.

Midstream sector

At present, the total length of onshore oil and gas pipelines is approximately 120,000 kilometres (not including oil and gas field gathering and transportation pipelines). The CNPC, Sinopec and the CNOOC monopolise the market by possessing approximately 95% of the market shares. Given that pipelines connect the upstream and downstream sectors, the latter cannot be independent from the former. Consequently, pipelines held by private companies are incapable of competing with those which are held by upstream companies.

Separation of plant and network The establishment of independent national pipeline companies was once the reform's biggest concern. However, the final step-by-step route for achieving this is now more moderate. The oil and gas giants will:

  • set up pipeline companies in anticipation of the separation;
  • invite various cooperative partners; and
  • separate the plant from the network.

Separation of midstream pipeline business The oil and gas heavyweights are encouraged to operate their pipeline businesses in the upstream and downstream sectors independently, at least financially, and have begun to take action in this regard. In November 2016 the CNPC split its gas sales and pipeline business and Sinopec plans to cooperate with private companies in the sale of refined oil.

Equitable third-party access mechanism Oil and gas pipelines, oil wharfs, liquefied natural gas receiving stations and the provincial and interprovincial networks are in a fragmented state, which has led to insufficient competition and wasted resources. Fair and open third-party access is beneficial to allowing social capital to enter the oil and gas field.

The reform of oil and gas imports and exports is mainly focused on the openness of importation and use rights. The import and export management reform is already underway; in 2015 more than 20 refiners were awarded non-state trade import certificates for crude oil and use rights for imported crude oil.

The existing reform requires the development of a system that will more actively monitor crude imports. This means that independent refiners will come under tighter scrutiny and supervision. According to the opinions, supervision is expected to cover all aspects of a refiner's operations, including whether quota holders:

  • are selling quotas to other refineries; and
  • adhering to all tax regulations.

The authorities must also improve the policies for oil product exports under the processing and general trade route.

Downstream sector

The opinions reaffirm the government's commitment to expanding the reform of state-owned oil and gas companies. The prime goal of the mixed-ownership reform is to create a market-oriented mechanism with eligible private enterprises. The state-owned companies are encouraged "to lose weight and be fit" and "to solve problems left over from history". Whether this is through lay offs or restructuring, it is a sensitive issue which would cause social instability.

The biggest problem stemming from China's refined oil pricing mechanism is that it cannot reflect the supply and demand of the entire market. China has been working on a market-oriented pricing mechanism for several years. However, there barely is a market due to the monopoly of state-owned oil and gas heavyweights, with Sinopec and the CNPC controlling around 60% to 70% of the market.

It is hard for market entities to have a purely market-driven domestic price. Therefore, the guidance price set by the National Development and Reform Committee is still the benchmark used by the domestic market. The reform emphasises that the pricing mechanism of refined oil should be more market oriented, while the government should step in when abnormal price fluctuations occur. It also encourages the development of oil and gas trading platforms in order to generate a market price. Further, as increasingly more entities enter into the market, more antitrust cases will emerge.

Comment

While the market-oriented reform of the entire oil and gas industrial chain includes no surprises, the opinions reflect the government's strong intentions behind the reform and send a positive signal to investors. However, the reform will not be an overnight success and significant resistance will be encountered during the process. When the overall plan is unveiled, the implementation of follow-up policies will be key.

This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.

For further information on this topic please contact Lin Shile or Meili Tan at Broad & Bright by telephone (+86 10 8513 1818) or email (shile_lin@broadbright.com or meili_tan@broadbright.com). The Broad & Bright website can be accessed at www.broadbright.com.