Market Access Report: Oil & Gas

Jones, Day, Reavis & Pogue

Faced with dramatic increases in energy demand, and serious environmental concerns over long-standing reliance on high-sulphur coal, China's energy industry is in the throes of reform. Indeed, recent years have witnessed a major restructuring of the domestic players and regulatory bodies, along with a marked groundswell of interest in developing alternative fuel sources including, most significantly, natural gas. With China's entry into WTO a foregone conclusion, the domestic oil and gas industry is now bracing itself for even more changes.

Current Environment

Upstream (Exploration & Production)

The domestic oil industry is currently structured such that China National Offshore Oil Corporation (CNOOC) is responsible for exploiting offshore petroleum resources, while China National Petroleum Corporation (CNPC) and China Petroleum Group Corporation (Sinopec) are generally responsible for onshore exploration and production (E&P) activities. China United Coal-bed Methane Corporation is responsible for coal-bed methane E&P. Foreign cooperation in onshore and offshore E&P activities are generally carried out through Ministry of Foreign Trade and Economic Cooperation (MOFTEC) approved "petroleum contracts" which are functionally equivalent to production-sharing agreements. Although Sino-foreign cooperation in offshore E&P dates back to the early 1980s, foreign cooperation in onshore E&P work has been much more limited.

Midstream (Pipeline Transportation)

Until relatively recently, opportunities for foreign participation in oil and gas pipeline systems were confined to offshore operations. However, following the 1997 revision to the Foreign Investment Industrial Guidance Catalogue  (外商投资产业指导目录) (the Investment Catalogue), foreign investment in the construction and operation of oil and gas pipelines is now "encouraged", subject to certain restrictions on foreign ownership percentages and excluding urban gas distribution networks. Exceptions do, however, apparently exist: foreign participants in China's mammoth 4000+ km West-East Gas Pipeline Project will purportedly be permitted to engage in urban gas grid construction in addition to taking an equity stake in the main pipeline project.

Downstream (Processing, Wholesale & Retail)

The Investment Catalogue does not expressly prohibit or restrict foreign investment in gas processing facilities and therefore such activities are arguably permitted. The most significant indication that the Chinese government will allow foreign participation in gas processing facilities is the Guangdong LNG project which includes a significant foreign stake in the joint venture that will own and operate the regassification plant.

Foreign oil companies are not currently permitted to participate in China's wholesale market for refined oil products. With regard to gasoline sales at the retail level, foreign companies may, technically, only set up service stations in China ancillary to their investments in highway projects.

Imports

MOFTEC and the State Economic and Trade Commission (SETC) administer an annual oil import plan and an oil import quota system for all grades of oil. Currently, only a handful of State-owned enterprises are permitted to directly import crude and processed oil. Since September 1998, the PRC government has also prohibited any import of diesel fuel or gasoline in order to balance the supply and demand of the domestic market.

Changing Landscape

The three main WTO-related changes that will most directly affect the China oil and gas industry are the reduction of tariffs, the elimination of certain non-tariff barriers to trade and the opening of the retail and wholesale markets to foreign participation. Foreign companies can also expect additional benefits from reforms ancillary to WTO entry, such as the introduction of more transparent and streamlined approval procedures, although the extent and timing of such systemic changes is uncertain.

Reductions in Tariffs

China's entry into WTO will affect tariffs on some, but not all, oil and gas products. For example, tariffs on gasoline will be reduced from 9% to 5%, on natural liquefied gas in a gaseous state from 6% to 0%, and on "other" liquefied petrol-gases from 6% to 3%, while tariffs on diesel, kerosene, spirit-type jet fuel, fuel oil and liquefied natural gas will remain unchanged.

Elimination of Non-tariff Barriers

China has agreed to eliminate quotas and licences on the import of refined petroleum products by 2004, and to increase quotas by 15% each year until 2004. The current import ban on gasoline and diesel fuel will also reportedly be lifted immediately upon WTO entry. Although it is not certain whether the quota system for crude oil imports will be lifted, the US-China WTO agreement does include a broad statement that "all quotas will grow by 15% annually until eliminated".

Enhanced Market Access

Retail distribution will be opened to foreign suppliers of processed oil by 2003 without any geographical, quantitative or ownership restrictions. Wholesale distribution of crude and processed oil will also be open to foreign participation by 2005, without any geographical, quantitative or ownership restrictions. Although State-owned enterprises will retain exclusive trading rights for imported crude oil and refined products, China did reportedly agree in its WTO agreement with the EU to allow the private sector to import 7.2 million tons of crude oil and 4 million tons of processed oil per year.

Conclusion

Although China's entry into WTO will certainly provide enhanced benefits for foreign oil and gas companies, cooperation with the domestic majors will still be required for most oil and gas work. China's oil and gas sectors also face a number of challenges independent of WTO, including the cost and time required to commercialize remote fields, the on-going reforms of the power industry and the price competitiveness of oil and gas compared with coal.

By Beth Bunnell and Richard Qiang,

Jones, Day, Reavis & Pogue, Shanghai