China Energy Sector Survey Part II: The Energy Institutions

The Ministry of Electric Power Industry, first created in 1955, was merged with the Ministry of Water Resources in 1983 to form the Ministry of Water Resources & Electric Power in order to consolidate oversight in both thermal and hydropower generation and transmission. Five years later, in 1988, further consolidation occurred when the Ministry of Energy was formed from parts of the former Ministries of Coal Industry, Nuclear Industry, Petroleum Industry and Water Resources & Electric Power. However, it was quickly abolished in 1993. Upon the ministry's dissolution, regulatory control over the electric power industry and coal industry was redistributed to a reconstituted Ministry of Electric Power and Ministry of Coal Industry. The State Economic & Trade Commission (SETC) was created in 1993 to coordinate the various energy industries that were now in the hands of separate ministries. The State Planning Commission (later to become the State Development & Planning Commission) continued to be responsible for long-term planning and policy development in the energy sector.

Significant regulatory changes in each of the major energy industries occurred in 1997 and 1998. The State Power Corporation was formed in 1997, and shortly thereafter in 1998 the Ministry of Electric Power was abolished. In its place, an Electricity Bureau was established within the SETC to oversee the State Power Corporation. Also abolished in 1998 was the Ministry of Coal Industry when the state mines managed by the ministry were handed over to the provincial governments. A State Administration of Coal Industry (SACI), to be supervised by the SETC, assumed regulatory responsibility for the coal industry. Also in 1998, the government consolidated the administrative functions of the Ministry of Chemical Industries and two of the national oil companies to create the State Administration of Petroleum & Chemical Industries (SAPCI), which was supervised by the SETC. By 2000, the SACI and SAPCI were disbanded. The SETC, assisted by respective industry associations, became the principal body overseeing the energy sectors.

More changes that further set the stage today were to occur in March 2003, which are discussed below.

EMERGENCE OF THE NATIONAL ENERGY COMPANIES

The tension experienced by the ministries and agencies charged to produce energy and to simultaneously regulate the sector caused an almost uniform response by the government to separate these functions, although the practical implementation of its response varied from industry to industry.

Oil and Gas

The earliest acknowledgement of the need to split the administration of the energy industry from the industry's commercial activities occurred in the oil and gas industry. At the time the national oil companies were formed, government administration and production functions resided with the Ministry of Petroleum Industry.

China National Offshore Oil Corporation

On February 15 1982, the State Council created China National Offshore Oil Corporation (CNOOC) as the first state-owned oil company, and it was given responsibility for activities in the territorial waters of China. CNOOC was formed as a PRC state enterprise with legal person status, and was equivalent to a state bureau under the State Council. By 1988, it came under direct State Council supervision.

CNOOC's principal responsibilities included development of the PRC's offshore oil and gas exploration, development and production operations, but still included many administrative responsibilities associated with its development operations, including oil field support services, provision of social services, and the day-to-day regulation of operations. Pursuant to the PRC Exploitation of Offshore Petroleum Resources in Cooperation with Foreign Enterprises Regulations (Offshore Regulations), CNOOC was given the exclusive right to cooperate with foreign parties, with the right to take up to a 51% interest in the production sharing contracts (PSC) awarded to foreign enterprises. Its charter also gave it the right to undertake independent offshore exploration, development and production operations, although the right to do so in independent operations offshore China was later to be shared with Sinopec National Star Petroleum Company and, in shallow waters (below five metres), with the other national oil companies.¹

China Petrochemical Corporation

China Petrochemical Corporation was the next national oil company to be formed, in 1983. It arose, in part, out of the separation of the refining and petrochemical functions of the Ministry of Petroleum Industry. China Petrochemical was a ministerial level enterprise and had responsibility for the processing and sales of refined petroleum products and petrochemicals, as well as overseeing the infrastructure required to do so. It also was responsible for the development and enforcement of policies in these areas.

A new corporate entity, also named China Petrochemical Corporation (hereafter referred to as the "new" China Petrochemical), was formed in 1988 as a PRC limited liability company, and given a quasi-monopoly to conduct international crude oil and products trading. The ministerial level or "old" China Petrochemical transferred most of its refining and petrochemical business to new China Petrochemical, but retained or transferred to other agencies its administrative responsibilities.²

China National Petroleum Corporation

China National Petroleum Corporation (CNPC) was formed in 1988 out of the onshore oil and gas exploration and production entities then remaining with the Ministry of Petroleum Industry (and thereafter the ministry was abolished, with its governmental functions transferred to the Ministry of Energy). CNPC's functions still included various governmental responsibilities, including the ministry's responsibility for providing ancillary social services, including schools, medical facilities and transportation infrastructure. On the commercial side, CNPC had exclusive responsibility for onshore exploration, development and production activities, both independently and in cooperation with foreign enterprises.

CNPC's authority was not limited to China, but also applied to overseas exploration and production, and associated refining and marketing of overseas production. It also received the right to import and export crude oil and refined products, including petrochemical products.³

Industry Restructuring

The oil and gas industry in China underwent a major reorganization beginning in March 1998. Key goals of the restructuring were to further separate regulatory and commercial functions, to improve the efficiency and competitiveness of CNPC and Sinopec and create world-class petroleum companies.

A key element of the restructuring was an asset exchange in which Sinopec transferred to CNPC numerous refineries, petroleum facilities and trading companies in the north-eastern, northern and western regions of China, and CNPC transferred to Sinopec various production enterprises located in eastern China. The upshot was an end to the monopolies that CNPC held in the onshore upstream and Sinopec held in the downstream areas, making each an integrated oil company with upstream, downstream and petrochemical operations. Rough geographical monopolies were maintained, with CNPC's assets being located primarily in China's north-eastern, northern and western regions, and Sinopec's assets located primarily in the south-eastern and southern regions.⁴

Restructuring also had as one of its purposes the goal of creating international-class petroleum companies. To do so, each of the national companies formed public stock entities whose shares would be made available to the public in a global stock offering.

PetroChina

CNPC formed PetroChina Company Limited (PetroChina) on November 5 1999, as a joint stock company with limited liability under the PRC Company Law(中华人民共和国公司法). In its restructuring agreement of March 10 2000, CNPC transferred to PetroChina substantially all of its onshore exploration, development and production interests, which included exploration and production enterprises; its refining, transportation, storage and marketing (including import/export) business; and service stations. The transfer also included associated oil and gas pipelines, research institutes and production sharing agreements with foreign enterprises.

CNPC retained a number of key assets, including CNPC's international projects, 3,600 gas stations and five chemical production facilities. And although CNPC did covenant not to compete with PetroChina in its principal areas of activity, it carved out exceptions for certain chemical complexes, marketing facilities, and international oil and gas projects. CNPC agreed to provide various services to PetroChina (finance, land leases, software licences, IP licences and technical assistance) through a "Comprehensive Products and Services Agreement", and granted PetroChina certain options to purchase its current and future interests in China and overseas. Conversely, PetroChina undertook to provide to CNPC limited products and services arising out of its operations.⁵

A global public offering of PetroChina Limited occurred in April 2000.

Sinopec

China Petroleum & Chemical Corporation (Sinopec Corp.) was formed as a PRC joint stock limited company on February 25 2000, with new China Petrochemical Corporation as its sole shareholder. As part of its pre-global offering restructuring, new China Petrochemical Corporation transferred most of its upstream and downstream interests to Sinopec Corp., as well as its business units responsible for the manufacture, sales transportation and trading (import/export) of petrochemical products.

China Petrochemical Corporation retained interests in certain petrochemical facilities, small capacity refineries and service stations, its oil field service businesses, and its ancillary service business responsible for construction, utility and social services.⁶

Sinopec Corp.'s global offering took place in October 2000.⁷

CNOOC Limited

The State Council formed CNOOC Limited on August 20 1999 pursuant to the HK SAR Companies Ordinance. CNOOC transferred to CNOOC Limited all of CNOOC's operational and commercial interests in the offshore oil and gas business, making CNOOC Limited the exclusive vehicle through which CNOOC engages in petroleum activities offshore China. Assets transferred included production sharing agreements with foreign enterprises, independent development projects, CNOOC's interest in Shanghai Petroleum and Natural Gas Co. Ltd, land use rights to various terminal facilities, loans and swap agreements with its banks, and employees to facilitate the transfer.

CNOOC also assigned to CNOOC Limited trademark licences, lease agreements for onshore facilities, and a wide range of administrative, social and oil field support services. As is the case with each of these reorganizations, CNOOC retained a number of assets, which included a petrochemical and LNG project in Guangdong province and a fertilizer plant in Hainan province. It also retained a number of administrative functions that it performed prior to the reorganization, such as: organizing international bidding and awards for offshore exploration; administration of certain aspects of PSCs; and the right to submit development plans, environmental impact and other reports to the PRC government.⁸

CNOOC proceeded with a global offering of CNOOC Limited in April 2001.

Electric Power

The first signs of an independent, commercial power entity appeared in 1985 when the State Council Coal-for-Oil Office contributed capital out of a special Coal-for-Oil Fund to form a group of nine Huaneng companies. Included among the nine companies was Huaneng International Power Development Company, a joint venture set up to attract foreign capital into the power sector. By 1988, the State Council approved the creation of China Huaneng Group Company.⁹

In 1997, pursuant to the policy of separating the roles of government and commercial enterprise, the State Council created the State Power Corporation.¹⁰ The SPC was a corporate entity wholly owned by the state and with enterprise legal person status. It was intended to serve the role as "operator" and "manager" of electric power assets held by the Ministry of Electric Power, and to implement these responsibilities under administrative oversight and supervision by the government.¹¹

The State Power Corporation's functions and responsibilities include: unified planning, construction, monitoring and management of the national power network; operation, management and modulation of inter-regional power grids and large-scale power plants that supply electricity across regions; and management of the state-owned shareholdings of its subsidiaries and affiliates.

Early in 2002, the State Council approved the Structural Reform Plan of the Power Industry.¹² A key purpose of the plan was to segregate generation and distribution assets. By December 2002, the State Council further approved a "Generation Assets Reorganization Scheme".¹³ Under this scheme, assets of the State Power Corporation were allocated to two grid companies, five generation companies and four ancillary enterprises. These entities were officially established on December 29 2002. As part of this reform, the State Power Corporation was abolished.

Coal

Since the beginning of economic reforms in the early 1980s, the government encouraged town and village coal mines. In 1998, all key state-owned mines previously under the direct management of the Ministry of Coal were handed over to provincial governments.¹⁴ The result was three forms of production units in the coal industry: state-owned key coal mines; state-owned local coal mines; and town and village coal mines.

Modern enterprise management was introduced to the coal industry beginning in 1995. A number of the key state-owned mines underwent restructuring to become enterprise companies, with some listing shares in China and overseas. However, many of the state-owned mines could not withstand the competition from the proliferation of smaller coal mines, especially after the State Council decided to liberalize coal prices in 1993. Massive oversupply of coal from the town and village coal mines drove coal prices down. In 1998, the State Council decided to shut down small coal mines with illegal mining and "irrational layout".¹⁵ The resulting reduction in coal output led to a rise in coal prices. But many state-owned mines could not survive. By 1999, the government took an unprecedented step and allowed poorly performing state mines to go bankrupt.

In the area of coalbed methane, China United Coalbed Methane Company Limited was established in 1996. It was specifically empowered by the State Council to conduct business activities relating to exploration for and production of coalbed methane gas. Since its inception, it has been involved in many projects with foreign partners to exploit resources in Anhui, Shanxi, Hubei and Ningxia.

CHINA'S INSTITUTIONS TODAY

Responsibility for the energy sector in China is generally divided between the regulatory functions of government and the commercial or production functions of the national energy companies, although the line is least clearly defined in the coal industry. The regulatory role is served by several national governmental bodies with overarching jurisdiction across the energy sector. There also are administrative or regulatory requirements that are peculiar to each industry.¹⁶

Responsibility for production of energy varies by industry. In the oil and gas industry, the function of commercial energy production is firmly placed in the national oil companies. In the electric power industry, we are still only at the beginnings of reform but the line between government administration and commercial production is brightening. The coal industry has yet to see a clear model of national coal companies, but appears to be moving in that direction.

National Level Administration

Any analysis of the regulatory structure of the energy industry in China starts with the near-universal constitutional proposition that the sovereign owns all mineral resources. The principal state bodies charged to oversee energy development in China are the National Development & Reform Commission (NDRC) and the Ministry of Land Resources (MOLAR). In matters relating to foreign trade and investment, the Ministry of Commerce (MOFCOM) will also be a major force. Since the major energy companies are centrally owned state enterprises, the State Asset Supervisory & Administration Commission (SASAC) will have a major role.

National Development & Reform Commission

The NDRC is the product of decisions made at the 10th National People's Congress in March 2003. It combines certain functions of the State Development & Planning Commission (SDPC) and certain functions of the now disbanded State Economic & Trade Commission (SETC).

A major responsibility of the NDRC is to plan the development and strategic upgrade of various industries that are key to the national economy, including the oil, natural gas, coal and power industries.¹⁷ An Energy Bureau within the NDRC is in charge of analyzing the development and utilization of energy resources both domestically and abroad, and to draw up plans, policies and strategy for energy sector development and reform. The Energy Bureau also supervises the oil, gas, coal and electrical power sectors. The National Oil Reserve Office within the Energy Bureau will manage the national oil reserve.¹⁸

The NDRC will be an influential force in shaping the investment regime for foreign investors in the domestic energy sector as well as in setting the pace for China's oil and gas ventures abroad. For instance, the Office for the Utilization of Foreign Capital is in charge of formulating strategy for foreign direct investment within China and coordinating China's investments overseas, which includes investments by the national oil companies.¹⁹

Other functions to be performed by the NDRC that will affect the energy sector include coordinating revisions to the Foreign Investment Guidance Catalogue and reviewing large scale exploration projects and projects using substantial foreign exchange abroad.

Ministry of Commerce

MOFCOM was formed in 2003 as a consolidation of the functions of the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) and certain functions of the State Economic and Trade Commission (SETC), which was abolished. MOFCOM has a broad range of responsibilities across the spectrum of China's economy, which includes international economic and trade relations, WTO compliance and foreign investment. MOFCOM promulgates the Foreign Investment Guidance Catalogue jointly with the NDRC.

The Foreign Investment Administration (FIA) within MOFCOM has direct responsibility over regulation of foreign investment. The FIA drafts plans, policies, and laws and regulations relating to foreign investment, and is responsible for their implementation and enforcement. Divisions within the FIA will set policies and mid-range planning for utilizing foreign capital within the industrial areas under its supervision.

For energy-related areas, two divisions within the FIA coordinate and guide the approval, filing and administration of projects involving foreign capital. The Service Trade Division has jurisdiction over: (i) public utilities in urban areas and various pipeline networks; (ii) onshore and offshore oil, gas and coalbed methane exploration and production; (iii) mining, including coal; and (iv) transportation. The Manufacturing Industry Division has jurisdiction over refineries, petrochemical, chemicals, metallurgy, power stations and related energy areas.²⁰

Ministry of Land Resources

The key functions and responsibilities of MOLAR are in the planning, administration, protection and utilization of China's natural resources. From a reorganization in 1998 that eliminated relevant government departments, MOLAR acquired jurisdiction over the administration of mineral resources.²¹ Today, it exercises its functions under laws and regulations stemming from the PRC Mineral Resources Law.²² MOLAR functions and duties that are directly relevant to the energy sector include: mineral surveys and appraisals, including utilization plans; supervision of local land resources bureaus and resolution of disputes; granting licences for mineral exploration and production; and administering the registration and assignment of exploration and production licences.²³

State Asset Supervisory & Administration Commission

The SASAC is a ministry-level commission that supervises the state-owned assets of all centrally owned enterprises other than those in the financial services industries, and charts the reform of the state-owned enterprises.²⁴ SASAC's principal role is to shepherd government reform and the restructuring of state-owned enterprises and assets by establishing standards for capital preservation and appreciation, perfecting corporate governance and administration, and applying high-level human resources management.

Industry-Specific Oversight

Oil and Gas

Today, no ministry or government body is charged exclusively with oversight of the oil and gas industry. This responsibility is divided among three of the national level governmental agencies described above: the National Development Reform Commission, the Ministry of Land and Resources and the Ministry of Commerce.

Through its Energy Bureau, the NDRC has responsibility for the approval of feasibility studies for oil and gas exploration, development and production, whether onshore or offshore. In addition, the NDRC must review investment projects proposed by national oil companies overseas; it also must review the involvement of foreign enterprises in oil and gas projects exceeding certain investment limits. Its responsibilities include publishing retail guidance prices for petroleum products; establishing unified natural gas prices and guidelines; approval of pipeline tariffs; publishing production targets; resolving pricing disputes between national oil companies; and publication of an annual natural gas guidance supply plan (for fertilizer supply).

MOLAR's principal authority over the oil and gas industry includes the designation of blocks for exploration; the approval of geological reserve reports; the review and granting of licences for independent and foreign oil and gas exploration and production; and the administration of the registration and assignment of exploration and production licences. Its authority is limited to the upstream area.

MOFCOM features in the regulation of the oil and gas industry in a number of areas. Due to its MOFTEC and SETC roots, a number of its functions have an "external" focus. While it has broad responsibility for the formulation of industry policy, its oil and gas oversight extends to two principal activities. First, it sets quotas and issues licences for the import and export of oil and refined products. Second, it approves PSCs and other joint venture arrangements with foreign enterprises.

The State Environmental Protection Administration (SEPA) is another relevant agency as the PRC Environmental Protection Law is applicable to the oil and gas industry, and regulates activities associated with exploration, development, production and refining activities, particularly where the installation or renovation of facilities or the discharge of pollutants is involved. An environmental impact report must be prepared for any new or renovated installations and the proponent must await certification that the proposed works are within the law's limitations on environmental impacts before proceeding with construction. Similarly, if a project proposes to discharge listed pollutants, a discharge permit must first be obtained.²⁵

The Environmental Protection Law also provides that offshore oil projects must comply with relevant laws and rules on ocean pollution. One such law is the Marine Environmental Protection Law. Detailed rules applicable to offshore projects are found in the Environmental Protection in Offshore Oil Exploration and Exploitation Regulations. It requires project operators to submit environmental impact reports that identify preventive or mitigation measures.

Electric Power

The newly formed State Electricity Regulatory Commission (SERC) holds the regulatory reins today. The SERC grew out of the power industry reform plan. This agency was established in December 2002 and began official operations on March 25 2003.

Its responsibilities include:

- implementation of a unified regulatory regime for the power industry;

- proposing laws and drafting regulations governing the power industry;

- development of proposals for the ongoing reform of the power industry;

- monitoring the operations of the power markets;

- proposing price adjustments in accordance with market conditions;

- investigation of rule violations;

- settlement of disputes arising in power markets;

- enforcement of standards and specifications, including environmental laws (in conjunction with environmental protection agencies); and

- administration of licensing procedures of power industry operators (Guobanfa [2003] No. 7).

The Ministry of Water Resources (MWR) is an important player in China's hydroelectric power industry. The MWR drafts and reviews proposals and feasibility study reports for large-scale capital construction projects. It recommends sites for the construction of large and medium-sized hydropower stations. It also provides guidance to enterprises responsible for the management of water supply and hydropower development, and oversees the monitoring and management of safety issues associated with reservoirs and dams of hydropower stations.²⁶

Coal

Activities in the coal industry are governed by the PRC Coal Law (1996) and related regulations. The Coal Law governs the establishment of coal mining enterprises, coal production and distribution, and transportation.

Following the March 2003 government reform, the NDRC (through, for example, its energy bureau and economics operations department) has become the key agency overseeing the coal industry on behalf of the State Council. MOLAR will be involved in reviewing applications to establish a coal mining enterprise, and in granting mining licences.

A licence must be obtained prior to the commencement of coal production. The Coal Law sets out certain conditions for granting the production licence. The State Council promulgated a set of administrative measures and detailed rules for administering the production licence process.²⁷ The jurisdictional authority for approval is divided into hierarchies (central or local).

The Coal Law also sets out conditions for granting permits to establish a coal distribution and transportation business. The State Council also has promulgated a set of administrative measures for administering the coal business permit process (the Administration of Coal Business Procedures). Once the coal business permit is granted, the applicant can register with the State Administration of Industry and Commerce (SAIC) or the local administrations of industry and commerce to obtain a business licence.

The import and export of coal is administered under a unified system. Upon approval by MOFCOM, qualified large-scale coal enterprises may engage in the coal import and export trade.

The Environmental Protection Law is also applicable to the coal industry. Operators must demonstrate that their proposed activities comply with applicable environmental laws or propose preventive or mitigation measures in order to receive a mining permit, production permit or coal business permit. The PRC Air Pollution Prevention Law also will have an impact on coal operations. It requires that coal mines producing high-sulphur and high-ash coal install coal washing facilities. It also requires installation of desulphurization and emission control equipment in new or expanded power plants. These measures are part of the government's efforts to promote clean coal technology.

MOLAR is the principal authority regulating the coalbed methane industry. Exploration and production of coalbed methane is mainly governed by the Mineral Resources Law and related regulations, e.g. the Administration of Registration of Mineral Resource Exploration Blocks Procedures, and the Administration of Registration for Exploitation of Mineral Resources Procedures. For foreign cooperation projects, the Onshore Regulations would also apply.

CHINA'S NATIONAL ENERGY COMPANIES today

A range of structures exists under the state energy company mantle. In oil and gas, the national oil company structure is most pronounced and akin to that in many other petroleum-rich countries in the world. In the electric power sector, the newly formed generation companies have the hallmarks of national energy companies, but the absence of any operating history makes a conclusive assessment premature. And the coal industry still labours under a more distributed structure, with a few "state coal companies" and a proliferation of provincial and local enterprises and mines dominating the scene.

Oil and Gas

PetroChina and Sinopec are today the dominant onshore operating companies in China. PetroChina has responsibility for provinces in the north, north-east and west of the country and Sinopec has responsibility in the east and south-east. As a result of the 1998 reorganization, each is now a vertically integrated company, with responsibility for exploration, development, production, refining and marketing in their respective regions. CNOOC Limited continues to be the principal operator in offshore China, with increasing international assets, and no downstream operations. Sinochem, the fourth national oil company, is a relative newcomer to the operational side of the oil and gas industry, having only assumed responsibility for exploration and production activities in 2002.

PetroChina

PetroChina is the largest oil and gas company in China, when measured by oil and gas production. It is structured into six key operating units: (i) exploration and production; (ii) refining and marketing; (iii) chemicals; (iv) natural gas and pipelines (including crude oil and refined products); (v) international; and (vi) import/export. PetroChina is authorized by the State Council to engage in oil and gas exploration and production activities both onshore and in offshore waters of less than five metres. As is the case with Sinopec and CNOOC and its controlling shareholders, PetroChina cooperates with CNPC (PetroChina's controlling shareholder) through a series of connected transactions for a wide range of products and services associated with its principal business operations.

PetroChina is the owner and operator of Daqing, China's oldest and largest oil and gas field. It also owns and operates the Liaohe and Xinjiang oil fields. Collectively, these fields comprise over two-thirds of PetroChina's domestic interests in oil. PetroChina also operates the natural gas fields of Sichuan and Changqing, with the latter being the largest natural gas region in China. In 2002, fields under PetroChina's ownership and control averaged daily production of 2.096 million barrels of oil and 1,658 million cubic feet of natural gas.

PetroChina's downstream operations include 23 refineries, which processed 569 million barrels of crude oil in 2002. It has 10,961 service stations that it owns and operates. Petrochina supplies the large majority of its crude oil to its own and Sinopec's refineries. Nearly all of the feedstock provided to PetroChina's refineries comes from its own production. PetroChina's 2001 joint venture with BP in Guangdong and Fujian provinces operated 293 service stations at the end of 2002. PetroChina also manufactures a wide range of petrochemical products through 13 chemical plants located in five provinces and three autonomous regions.

PetroChina operates the largest network of pipelines in China, due to the near-exclusivity enjoyed by CNPC, its controlling shareholder, in the upstream business prior to reorganization in 1998. The network includes over 12,000 kilometres of gas pipelines, 9,200 kilometres of crude oil pipelines and 2,276 kilometres of refined products pipelines. PetroChina also is the sponsor of the 2,500-mile West-East pipeline that is under construction from Xinjiang to Shanghai.

PetroChina's overseas operations have to date included interests in south-east Asia, including Indonesian interests acquired from Devon Energy and Amerada Hess. PetroChina imports and, to a lesser extent, exports crude oil and refined products through one of its subsidiaries, China National United Oil Corporation, which has a licence and quota to import and export crude oil and refined products.²⁸

Approximately 90% of the share capital of PetroChina is owned by CNPC, as controlling shareholder. Brandes Investment Partners, BP Investments China Limited and Berkshire Hathaway Inc. own the remaining shares.

Sinopec

Today, Sinopec is the second largest integrated petroleum company in China. Its organizational structure, which emphasizes its background in the downstream business, has four key operating units: (i) exploration and production; (ii) chemicals; (iii) refining; and (iv) oil products sales. Like PetroChina, Sinochem is authorized by the State Council to engage in oil and gas exploration and production activities onshore, and offshore in waters less than five meters deep.

Sinochem held 294 exploration licences and 193 production licences, including licences in the Shengli field in Shandong, China's second largest oil field, at the end of 2002. It operates 11 producing fields, which in 2002 had an average daily production of 739,000 barrels of oil per day and 490 million cubic feet of natural gas per day. It produces 23% of the total crude production and 15% of the total natural gas production in China.

Primarily because of historical circumstances, Sinochem is the largest refiner and seller of refined products in China, with 25 refineries processing 105 million tons of oil in 2002. Only 27% of the feedstock to these refineries is supplied by Sinopec operations, while over 50% is supplied by imported oil. Sinopec also operates China's largest distribution network for refined petroleum products, which includes 19 provinces in its region. It operates 24,000 service stations, with another 4,000 being operated by third parties. It also is the largest petrochemical manufacturer in China through its operation of 17 petrochemical plants. Sinopec's 70%-held subsidiary, China International United Petroleum and Chemicals Co., Ltd, is licensed to import crude oil and refined products subject to quotas set by MOFCOM.²⁹

About 55% of the outstanding share capital of Sinopec Corp. is owned by the (new) China Petrochemical Corporation. China Development Bank, China Xinda Asset Management Corporation and the general public account for the second largest bloc of shareholdings.

CNOOC Limited

Unlike PetroChina and Sinopec, CNOOC Ltd is technically considered an "independent" since its exploration and production assets are independent of any downstream assets. Along with Sinopec National Star Corporation, it has co-extensive responsibility for independent petroleum activities in the territorial waters of China at depths greater than five metres deep. Operations in shallow waters are shared with PetroChina, Sinopec and Sinopec National Star Corporation. CNOOC Ltd has no onshore jurisdiction.

Like its sister companies, CNOOC Ltd conducts operations both independently and with foreign partners. Its largest producing area is in Bohai Bay, followed by production in the western South China Sea. At the close of 2002, CNOOC Ltd's domestic interests produced an average of 298,625 barrels of oil per day and 272,000 mcf of natural gas per day from both independent operations (CNOOC Ltd sole operations) and those involving foreign enterprises. Slightly more than half of its production came from its cooperative joint ventures with foreign partners.³⁰

CNOOC Ltd has the option to participate in LNG projects in which CNOOC invests, including the right to acquire CNOOC's 33% interest in the Guangdong LNG import and re-gasification terminal, as well as the associated upstream natural gas reserves. It also has options with respect to CNOOC's interest in a natural gas distribution system in Zhejiang province, pipeline and LNG facilities in Shandong province, as well as in CNOOC's agreement with the Fujian provincial government covering natural gas supply and market development there.

CNOOC Ltd's international assets, which are operated in conjunction with foreign partners, are considerable. It owns a 12.5% interest in the Tangguh LNG project, which is comprised of several offshore Indonesia PSCs. (The Tangguh partners have a 25-year contract to supply 2.6 million tons per year of LNG to an LNG terminal project in Fujian province.) CNOOC Ltd has acquired Repsol YPF S.A.'s interest in four PSCs in Indonesia in April 2002, as well as a 39.5% interest in a PSC in Indonesia's Malacca Strait. Most recently, CNOOC Ltd is reported to have signed an agreement to acquire an interest in the Gorgon LNG project off the Northwest Shelf of Australia, including the associated upstream reserves.³¹

CNOOC owns about 70% of the outstanding share capital of CNOOC Ltd.

Sinochem

Sinochem is the newest entrant in the field. Historically, Sinochem has been an export and import company with broad, although not exclusive, responsibility for crude oil and petroleum products. Since 2002, it has been authorized to pursue exploration, development and production activities abroad. It has since acquired Atlantis Norway Holdings HS, which owns oil and gas blocks in Tunisia, Oman and the United Arab Emirates.³¹

Sinochem's most recent restructuring has not affected its prominence in the import and export of petroleum and petrochemical products in China. It also continues to be active in oil transportation, terminals and storage, as is exemplified by its Aoshan Terminal. Similarly, Sinochem has a large presence in the transportation and distribution of petrochemicals through its joint venture ownership in the Shanghai Orient Terminal Company. It also owns a 33.6% interest in the WEPEC joint venture oil refinery in Dalian. Sinochem's import, export and domestic sales of fertilizer account for 60% of the Chinese fertilizer market. It also produces a range of petrochemical products through its chemicals business.

Electric Power

As a result of the 2002 Structural Reform Plan of the Power Industry and the ensuing Generation Assets Reorganization Scheme, two grid companies, five generation companies and four ancillary companies were formed.

The five generation group companies are: Huaneng,³² Datang, Huadian, Guodian and China Power Investment. The size, quality and geographic distribution of the assets are roughly even, with each generation company owning no more than 20% of the nation's generating capacity. The allocation included assets in large-scale hydroelectricity projects and shares of smaller power companies previously held by the State Power Corporation. But it did not include the China Three Gorges Project Corporation, which had been established in 1993 and operates independent of the five generation companies.

As for grids, two companies have been formed: the State Grid Corporation of China (State Grid) and the China Southern Grid Company Limited (Southern Grid). The State Grid is responsible for establishing five regional grid operators. They are: North China Power Grid Co. Ltd; Northeast Power Grid Co. Ltd; Northwest China Power Grid Co. Ltd; East China Power Grid Co. Ltd; and Central China Power Grid Co. Ltd.

The Southern Grid will consist of the grid assets of Guangdong Electric Power Co. and Hainan Electric Power Co. and the grid assets of the State Power Corporation in Yunan, Guizhou and Guangxi.

The four ancillary companies are: China Electric Power Engineering Consulting Group; China HydroPower Engineering Consulting Group; China National Water Resources & HydroPower Engineering Corporation; and China Gezhouba Group. These companies provide support services to the electric power industry.

Coal

Except in the case of coalbed methane, the concept of a national coal company or similar entity undertaking commercial activity on behalf of the government has not taken hold. There are a number of coal corporations in China, but none yet serves a role in the coal industry that is analogous to the roles served by the national oil companies or the power generation companies. However, the government has plans to nurture the development of several large-scale group companies to enable them to compete in the global coal economy. Some of these coal companies will have integrated business activities covering coal mining and production, power generation, transportation and shipping. Two of these companies are China National Coal Group Corporation and Shenhua Group Corporation Limited.

The predecessor of the China National Coal Group Corporation (CNCGC), the China Coal Import and Export Corporation (CCIEC), was formed in July 1982.³³ Currently, the CNCGC oversees an integrated coal operation from production to distribution, import and export, power generation, mining machinery, chemicals, high tech industries and finance. It has established trade and economic cooperation with more than 50 countries and areas around the world.

Shenhua Group Corporation Limited (Shenhua) was first created in October 1995 by carving out certain coal businesses from the Huaneng Group. Today, Shenhua is the largest coal enterprise in China with integrated coal mining, transporting and power generation operations. It operates mines in the Shenfu Dongsheng coal field, which straddles Shaanxi province and Inner Mongolia. Recently, Shenhua disclosed that it had held talks with ChevronTexaco to discuss opportunities for cooperation in a coal liquefaction project to which the government had given high priority. First commercial production is anticipated to come on line in 2005.

The future of China's key coal companies may be intertwined with the generation companies created in the recent power industry reforms. For instance, CNCGC announced that it has entered into a Long Term Strategic Cooperation Framework Agreement with Huaneng in June 2003. The cooperative arrangement envisions: (i) a coal buy/sell agreement to provide Huaneng's power generation plants with a stable supply of coal; (ii) co-development of coal production bases in China and abroad; (iii) co-development of coal gathering and distribution centres in China's coastal regions; and (iv) building "coal by wire" power plants at CNCGC's coal mines. In August 2003, Shenhua also announced that it had entered into a Long Term Cooperation Agreement with Huaneng. It was also reported that China Power Investment entered into a Strategic Cooperation Framework Agreement with Pingdingshan Coal Group.

In the area of coalbed methane, the China United Coalbed Methane Company Limited (CUCMC) is specifically empowered by the State Council to conduct business activities relating to coalbed methane gas. It currently has about 20 blocks under exploration with foreign partners who, as a matter of practicality, are limited to companies with technology and operational experience in coalbed methane exploration and production. Operations are conducted pursuant to production sharing contracts that are similar in form to PSCs used for oil and gas activities. As provided in the Onshore Regulations as amended in 2001, CUCMC is the only entity authorized by the government to partner with foreign investors to undertake coalbed methane exploration, development and production.

FUTURE CHALLENGES

The energy industry in China is the focus of increasing attention and concern by both the central government that is charged to regulate it and by the national energy companies that are responsible for producing the much-needed energy supplies. Hardly a week passes without a new report about the escalating challenges facing China's energy institutions to identify a sustainable source of supply for the country's growing energy demands. Meeting these demands will require efficiency both in the oversight and in the production of energy resources.

The challenge to both the regulators and the national commercial operators is clear. The regulators have a broad responsibility to both facilitate energy production and to manage production in such a way so as to maximize the benefits internally. The challenges in doing so will arise in a number of areas, including establishing appropriate production and pricing guidelines, import and export licences and quotas, and environmental standards. Actions in each of these areas will affect the viability of the industries it regulates and the level of supply they produce. In addition, the WTO presents a challenge to the government that requires it to open its energy markets while at the same time ensuring a steady stream of energy production by the new regime demanded by WTO.

For the national energy companies, the pressure to produce is increasing. And as the demand for energy grows, so does the competition for this energy, whether within China or outside its borders. With liberalization under the market access agreements subscribed to as part of WTO membership, the once-secure markets in China eventually will have to face foreign companies that will compete with the Chinese national energy companies to produce or import China's badly needed supply. In addition, developing environmental standards will raise the bar for Chinese companies and foreigners alike. Likewise, around the globe, there will be increasing competition for the scarce energy resources that many nations, including China, seek. This will also require the Chinese national energy companies to perform at international standards.

In the next and last part of this series, we will look at the legal framework for foreign investment in the Chinese energy sector, including areas that are yet to open to foreign investment.

Endnotes

1 See generally China National Offshore Oil Corporation Global Offering Prospectus, pp. 46-60.

2 See generally China Petroleum and Chemical Corporation Global Offering Prospectus, pp. 77-82.

3 See Guobanfa [1988] No. 44. The PRC Exploration of Onshore Petroleum Resources in Cooperation with Foreign Enterprises Regulations (the Onshore Regulations, adopted in 1993), further defined CNPC's right to enter into exploration and production arrangements with foreign companies onshore. See also PetroChina Company Limited Global Offering Prospectus, pp. 73-77.

4 See Guobanfa [1998] No. 14. See also China Petroleum and Chemical Corporation Global Offering Prospectus, pp. 58-59.

5 PetroChina Company Limited Global Offering Prospectus, p. 74-76.

6 See generally China Petroleum and Chemical Corporation Global Offerings Prospectus, pp. 77-82.

7 Shortly thereafter, the Onshore Regulations were revised to give Sinopec the right to enter into cooperative arrangements with foreign enterprises.

8 See generally CNOOC Global Offering Prospectus, pp. 46-60.

9 See a chronology of events (in Chinese) found in the web site of China Huaneng Group (www.chng.com.cn); see also Huaneng Power International, Inc.'s Annual Report on Form 20F, p. 17.

10 State Council Notice Concerning the Formation of the State Power Corporation (Guofa [1996] No. 48). The policy to create the State Power Corporation could also be traced to the Ninth Five Year Plan and the 2010 Long Range Objectives Outline.

11 With the establishment of the State Power Corporation, Huaneng Group Company was put under the SPC as a wholly owned subsidiary.

12 See press release of the State Development Planning Commission, April 11 2002. An English translation was published in China Law & Practice, June 2002, 16(5), pp. 34-36.

13 According to a Xinhuanet news report, Beijing, December 29 2002.

14 See Guofa [1998] No. 22.

15 See Guofa [1998] No. 43.

16 It is beyond the scope of this article to analyze the provincial or country administrative organs, or even the various tangential national bodies that have an influence on the regulation of the energy sector.

17 See Guobanfa [2003] No. 27, para. II-6.

18 Ibid, para. III-12.

19 Ibid, para. III-9.

20 See Guobanfa [2003] No. 29; Shangbanfa [2003] No. 7.

21 See Guobanfa [1998] No. 47.

22 These laws and regulations include: the PRC Mineral Resources Law; the PRC Mineral Resources Law Implementing Rules; Administration of Registration for Exploitation of Mineral Resources Procedures; Administration of Registration of Mineral Resource Exploration Blocks Procedures; Transfer of Exploration Rights and Mining Rights Procedures; and the Administration of Granting and Assigning Mining Industry Rights Tentative Provisions.

23 A detailed analysis of the mining exploration rights in the PRC can be found in Ward and Izzard, "Exploration Rights in the PRC: The 'How to and Where to Guide'," China Law and Practice, May 2003, 17(4), pp. 20-22.

24 See Guobanfa [2003] No. 28.

25 There are additional regional and local environmental standards governing principally infrastructure siting and discharges.

26 See Guobanfa [1998] No. 87.

27 Administration of Licensing of Coal Production Procedures.

28 See generally PetroChina Form 20F (June 2003), pages 15-46.

29 See generally Sinopec Form 20F (June 2003), pages 13-28.

30 See generally CNOOC Form 20F (June 2003), pages 22-39.

31 In addition to these energy-related activities, Sinochem owns interests in hotel and catering, financial services and investment management, shipping, information technology and tendering.

32 In January 2003, the State Council approved the reorganization of the Huaneng Group Company (Guohan [2003] No. 9).

33 In 1992, its name was changed to China National Coal Industry Import and Export Corporation. In 1997, China National Coal Industry Import and Export (Group) Corporation was formed by incorporating several coal-related entities, including China Coal Sales and Transportation Corporation, China Local Coal Mines Corporation, China Coal Production Technology Development Company and Pingshuo Coal Industry Company. In 1999, the company incorporated another eight coal-related entities. In April 2003, the company changed to its current name.