Bidding Successfully for Oil and Gas Projects in the PRC

Exploitation of Oil and Gas Resources

Foreign investors wishing to participate in the exploration for, and exploitation of, oil and gas in China are first of all subject to the laws in relation to foreign investment in this sector. According to the PRC Exploitation of Offshore Oil Resources in Cooperation with Foreign Parties Regulations (国务院中华人民共和国对外合作开采海洋石油资源条例) (the Offshore Regulations, promulgated by the State Council on January 30 1982 and amended on September 23 2001), only China National Offshore Oil Corporation (CNOOC), a state-owned oil corporation, is licensed to undertake all activities relating to the exploitation of offshore oil and natural gas resources. All participation of foreign companies relating to offshore oil and gas resources has to be undertaken cooperatively with CNOOC through a bidding process.

Likewise, the PRC Exploitation of Onshore Oil Resources in Cooperation with Foreign Parties Regulations (the Onshore Regulations, promulgated by the State Council on October 17 1993 and amended on September 23 2001) , stipulate that only China National Petroleum Corporation (CNPC) and China Petroleum and Chemical Corporation (Sinopec) are licensed to undertake activities relating to the exploitation of onshore oil and natural gas resources. Therefore, foreign players wishing to undertake activities relating to onshore oil and gas resources can only do so through cooperation with either CNPC or Sinopec through bidding or negotiation.

Although risk exploration and exploitation of oil and gas is "encouraged" pursuant to the Catalogue as mentioned above, the form of foreign investment is restricted to co-operative joint ventures. A foreign investor is therefore subject to the PRC, Sino-foreign Cooperative Joint Venture Law (中华人民共和国中外合资经营企业法) (the CJV Law) and related laws on foreign investment in general once it has won the bid in relation to a particular project.

Bidding Activities

The Bidding Law is the main legal basis regulating bidding activities to ensure that all contracts for major infrastructure and government-funded projects are awarded through a system of competitive tender. Implementing regulations issued by the SDPC pursuant to the Bidding law cover the scope of the Bidding Law, the publication of bidding information and provisions for evaluation of bids.

In addition, Sinopec promulgated its own regulation on bidding within its group company (the Sinopec Regulations, effective December 23 1999). These regulations apply to all bidding activities for construction projects within the group, including those in cooperation with, or jointly invested by, foreign companies. Therefore, any onshore oil and gas projects in cooperation with Sinopec will be subject to the Sinopec Regulations as well as the Bidding Law and its relevant regulations.

China's recently enacted Government Procurement Law (政府采购法) (effective January 1 2003) does not cover the bidding activities of state-owned enterprises such as CNOOC, CNPC and Sinopec.

The scope of application of the Bidding Law is very broad. Article 3 provides that all construction projects falling under specified categories must go through the bidding process if the value of the whole project or certain contract is above its relevant threshold value. The tender requirement applies to the survey, design, construction, supervision and procurement work for such projects. Oil and gas projects fall under the category of large infrastructure projects and public utilities projects that have a bearing upon the public interest and public safety. They are subject to bidding requirements under the Bidding Law if any of the following applies:

(1) any single construction contract is over
Rmb2 million (about US$240,000);

(2) any single contract of procurement for important equipment, material and other goods is over Rmb1 million (about US$120,000);

(3) any single contract for services of exploration, design or supervision is over Rmb500,000 (about US$60,000); or

(4) any single contract is less than all the above criteria, but the total investment for the project is over Rmb30 million (about US$3.6 million).

Due to the nature and scale of oil and gas projects, there will rarely be any project that will fall below the above thresholds. It is also worth noting that for any projects in cooperation with Sinopec, the bidding threshold under the Sinopec Regulations is Rmb3 million (about US$360,000) or over in project value (based on the value approved in the feasibility study).

Some projects might use loans from international organizations, such as the World Bank and the Asian Development Bank or foreign governments - including their agencies such as export credit agencies - or aid funds. The lender or fund provider of such projects can determine the bidding procedure of such projects according to its own regulations, so long as such regulations are not contrary to China's public interest.

A Practical Guide

Bid Invitation

If a project is subject to the bidding requirements under the Bidding Law or the relevant regulations, the bid inviting party (which will be CNOOC, CNPC, Sinopec or their subsidiaries or agents in the case of oil and gas projects) may put the project out for bid through public tender or tender by invitation. Public tender should be used for most straightforward construction projects, as tender by invitation is only allowed under the Bidding Law if, for certain key state or local projects, public tender would not be the suitable method, and provided the approval of SDPC or the provincial government is obtained. The Bidding Law also stipulates that any project wholly funded by the state or where state funds (including funds of state-owned enterprises such as CNOOC, CNPC and Sinopec) constitute a controlling or dominating stake, only the public tender method may be used.

According to the Sinopec Regulations, however, the method of tender by invitation shall generally be used for construction projects in relation to petrochemical projects, oil and gas exploration, production and storage projects. This is due to the complex nature of these projects, the know how and technology involved, and the significance of their impact on public safety and environmental protection. Although technically such provisions in the Sinopec Regulations do not apply to projects outside the Sinopec group, in practice similar approaches are adopted by projects involving CNOOC or CNPC.

For projects using tender by invitation, the bid invitation shall be sent to no less than three potential bidders capable of undertaking the project. It is therefore important for foreign players to establish strategic relationships with their counterparts in CNOOC, CNPC or Sinopec.

All projects subject to public tender must be published in designated newspapers and websites. While China Daily is the only designated newspaper for publication of invitation to bid to foreign entities, all notices published on any of the designated newspapers should also be posted on the China Procurement and Bidding website authorized by the SDPC (www.chinabidding.com.cn). Under the Sinopec Regulations, bid invitation should also be published in Zhongguo Shihua Bao (China Petrochemical Daily).

Both the Bidding Law and the Sinopec Regulations require the verification of potential bidders' qualifications under certain circumstances. Under the Sinopec Regulations, any potential bidders for oil and gas exploration, production, construction and storage projects should apply to the bidding management committee of the Sinopec group for a petroleum and chemical construction project bidding qualification certificate before they can participate in any bids. Similar qualification certificates will likely be required for non-Sinopec group projects as well.

The bid invitation documents shall contain certain requirements in relation to the project, including substantive conditions and technical and pricing requirements, the standards for the examination of bidders' qualifications and for bid evaluation, together with the principal terms of the contract to be entered into. To ensure fairness and impartiality, the bid inviting party is prohibited from stipulating a specific producer or supplier or other particulars that favour or preclude potential bidders. However, in practice, bidders should beware that seemingly objective technical requirements may be subject to challenge if they have the effect of prejudicing other bidders, especially where patented technology or specific know how is involved.

Submission of Bids

The Bidding Law prohibits collusion between bidders or between the bidder and the bid inviting party. But it allows two or more entities to organize a consortium and jointly submit a bid as a single bidder. Qualification requirements for the bidder, in this case, apply to each consortium member. In the past, the engagement of the same legal or financial advisors by potential bidders who are not part of a consortium have led the relevant supervising authority to raise questions of collusion. All bids are required to be opened publicly and the contents announced in public. Bidders should therefore consider the extent of detail in their bid documents and balance it against the impact of sensitive information being disclosed to their rivals. Bidders can supplement or amend their bid documents provided it is done before the deadline.

The Bidding Law requires the winning bidder to undertake the project on the basis of a turnkey contract. Subcontracting of non-principal, non-key parts of the work by the bidder after its bid is accepted should be specified in the bid documents, or approved by the bid inviting party. The subcontractor undertakes joint and several liability with the winning bidder for the subcontracted part of the project. The winning bidder may not, however, transfer the project to any other person, or divide the project into parts and transfer them to others. Further subcontracting by the subcontractor is also prohibited.

Bid Evaluation Process

The SDPC and other relevant ministries promulgated the Bid Evaluation Committees and Methods Tentative Provisions (the Tentative Provisions, effective July 5 2001) pursuant to the Bidding Law to address various irregularities in the bid evaluation process and to ensure that principles of fairness and impartiality are
upheld.

Pursuant to the Tentative Provisions, at least two-thirds of the members of the bid evaluation committee should be experts in relevant areas. They should be chosen either randomly from a pool of experts or, in the case of particularly complex projects, nominated by the bid inviting party. Members of the evaluation committee shall not be connected to any of the bidders in any way and shall not be from the authority with jurisdiction over the project or from the administrative supervisory authority. The names of the committee members shall be confidential until after the winning bidder is announced.

The evaluation process is divided into preliminary and detailed evaluation. Only standards specified in the bid invitation can be used and they should be reasonable and have no preference for, or preclusion of, certain bidders. During preliminary evaluation, if a bidder is found to have used unlawful means, such as collusion, deception or bribery, the evaluation committee will declare such bid void. A bidder who quotes a significantly lower price than others should be conscious of the risk of such a bid being declared void for being below cost.

Deviation from the bid invitation document is listed for each bid during the preliminary evaluation, resulting in bids with major deviations declared to be void. Major deviations include failure to provide requisite bid security (under the Sinopec Regulations, all bids shall be accompanied by a bid security of Rmb100,000-300,000, about US$12,000 to US$36,000, or a letter of guarantee from a bank), bid documents with no authorized signature or official seal, and failure to satisfy technical or other major standards or requirements. Minor deviations will be quantified and taken into account during detailed evaluation.

The detailed evaluation looks at the technical and commercial presentation between the bids. The lowest bid price method is generally used for projects with general technological and performance criteria. However, in the context of oil and gas projects, the comprehensive evaluation method is more likely to be used. Pursuant to such method, a bidder who meets to the greatest possible extent, all of the overall evaluation standards shall be recommended by the committee as the winning bidder. The committee will weight the results of the quantification of various technical and commercial factors contained in the bid invitation document and calculate the comprehensive assessment price or score of each bid. The winning bidder may also submit alternative bids for evaluation by the committee, if allowed under the bid invitation document.

Bid Award and Signing of the Contract

For projects using state funds or state financing, the bid inviting party is obliged to choose the first ranking bidder recommended by the committee as the winner. It can also authorize the committee to determine the winning party directly. It is worth noting that under the Sinopec Regulations, if all things are equal, the bidder from within the Sinopec group is preferred.

There is a time limit of 30 working days during which the bid inviting party and the winning bidder shall enter into the contract for the project. The limit is 15 days in the case of projects subject to Sinopec Regulations. In practice, large infrastructure projects involving foreign investment have hardly ever met such time limits; the extent of documentation for ancillary contracts relating to the project or the establishment of the joint venture and the time needed for various joint venture approvals, negotiations and financing arrangements means that such time limits are often unrealistic. The parties involved therefore may need to reach an understanding with the relevant supervising authority in this respect.

The Bidding Law provides that the winning bidder and the bid inviting party may not enter into any agreement that conflicts with the substantive content of the principal contract. It raises uncertainty as to what extent the parties have the freedom to enter into further agreements in relation to matters not originally stipulated in the bid or in relation to other ancillary documents under the project.

Challenging Bid Award and Remedies

The parties involved in a bid are given certain procedural rights to challenge the bidding process if the prescribed requirements under the Bidding Law are not adhered to. There are detailed provisions on the penalties imposed on various irregular activities during the bidding process, including invalidation of the bid, fine for the offending entity or personnel concerned, disciplinary proceedings (against persons concerned), disqualification from future bidding activities and payment of compensation. As can be seen, such measures are administrative in nature, a special feature of law enforcement in China.

The power to make decisions on administrative penalties rests with the relevant administrative supervisory authority designated by the state. The state may also decide to inspect the whole bidding process in certain major infrastructure projects. While the advantage of the administrative approach is the speedy resolution of complaints in most cases when compared with going through the courts, the potential disadvantage is concern over the fairness and transparency of administrative proceedings and the influence from various sources over such supervisory authority during its decision making process. Some supervisory authorities are closely connected with companies in the same sector. For example, under the Sinopec Regulations, breach of bidding requirements is dealt with by the Disciplinary Department and Engineering and Construction Department within the Sinopec group itself.

There is no provision in the Bidding Law and the relevant regulations on the right to take action through the courts, although criminal liability can be imposed if certain actions constitute a criminal offence. If a party were to pursue a matter through the courts, it is unclear whether such action would constitute a civil action (treating the parties involved as parties in a commercial transaction) or an administrative action (treating the action or the decision of the bid inviting party as an administrative decision). Informal opinions from judicial officials suggest that the former may be the case. Obviously, challenging the disciplinary decision of a supervisory body will be treated as an administrative action.

In practice, bidders will often weigh up the benefit of pursuing any action relating to irregularities against the potential cost it may carry in its relationship with its Chinese partners. However, the fact that such penalties exist undoubtedly serves as a deterrent to anyone tempted to step over the line.

Discrepancy between the Bidding Law and the Sinopec Regulations

It is unfortunate that the Sinopec Regulations, issued pursuant to the Bidding Law, contain quite substantial differences from the Bidding Law and its implementing rules. The main discrepancies exist in various time limits. In most cases the Sinopec Regulations allow only half the time as stipulated under the Bidding Law for different contractual and project issues to be completed. Other matters include different threshold values for the bidding requirement to apply and lower fines payable by an offending party. Admittedly, the Sinopec Regulations pre-date the various SDPC implementing rules. This does not, however, explain the deviation of the Sinopec Regulations from the Bidding Law itself. The SDPC Tentative Provisions provide that in case of discrepancy between the Tentative Provisions and regulations on bidding which pre-dates the Tentative Provisions, the Tentative Provisions shall prevail. It is hard to ascertain whether this provision applies to the Sinopec Regulations. In our view, we believe that the Bidding Law and the Tentative Provisions will prevail over the Sinopec Regulations.

Conclusion

Under its WTO accession agreements, China has undertaken to conduct procurement in a transparent manner and provide foreign suppliers and contractors with equal opportunity to participate in the procurement process. Both before and after its accession to the WTO last year, China made substantial efforts to deliver on its commitments by amending existing laws and regulations (e.g. by deleting provisions on preference for domestic raw material and facilities as it did in the Offshore Regulations and Onshore Regulations) and by introducing new legislation in this regard, such as the Bidding Law and the Government Procurement Law.

The Bidding Law and relevant regulations such as the Sinopec Regulations provide a road map to potential investors on the procurement process for oil and gas projects. Despite the "teething" problems between regulations from different state departments, the implementation of the spirit of the Bidding Law is a major step forward for China in bringing its public procurement in line with international practice.

The above is based on our understanding of relevant PRC law and practice and experience in representing foreign companies in their business activities in the PRC. As foreign lawyers, we are not authorized to practice law in the PRC and cannot express a formal legal opinion on PRC law.