IOVERVIEW

Energy regulation in China involves a number of stakeholders including various governmental authorities that heavily regulate the energy sector, monopolistic state-owned enterprises (SOEs), private companies that are trying to catch up, foreign companies that have had varying degrees of success, and a vast number of consumers. Currently, and for the foreseeable future, energy regulation in China is anchored in China’s ambitious economic restructuring agenda. Top priority is being placed on environmental goals and the deployment of cleaner energy in China’s economic reform plan. The ‘energy revolution’ proposed in the 13th Five Year Plan for National Economic and Social Development (2016 to 2020) is divided into three main sections, namely the upgrade of the energy structure, the development of energy transmission network, and the establishment of a smart energy internet.

China, as one of the largest economies globally, is deeply embedded in the global energy value chain. The effects of China’s energy consumption and production extend well beyond its borders.

China’s prominent role in the global energy market underlines the importance of understanding China’s domestic energy regulation regime and its market structure. This chapter aims to provide an overview of China’s energy market and regulatory regime with a focus on oil and gas, power, and renewable energy from a foreign investment perspective. We have endeavoured to state China’s energy regulation and practice on the basis of the materials available to us as of March 2019.

IiREGULATORY REGIME

iRegulators

Oil and gas

The Ministry of Natural Resources (MNR) is responsible for the supervision and administration of the exploration and exploitation of mineral resources throughout China. It has the authority to grant the licences required for the exploration and production of crude oil and natural gas in China. It also plays a role in examination and approval of blocks open to private and foreign investment.

The National Development and Reform Commission (NDRC) is in charge of setting out and implementing policies in respect of the oil and gas sector. It is also responsible for approving certain investment projects. The National Energy Administration (NEA) is established under the NDRC, with broad duties ranging from drafting energy strategies, proposing reform advice, implementing the management of energy sectors. NEA was previously charged with the authority to exam and approve the overall development plans for individual upstream oil and gas projects (ODP); however, in February 2019, the approval requirements for ODP were officially removed, and were replaced with a record filing procedures and ongoing, post-event supervision by NDRC and NEA.

The Ministry of Commerce (MOFCOM) was previously in charge of review and approval of entry into and amendments of all production sharing contracts (PSCs). This approval is no longer required, and has been replaced with a record filing requirement at MOFCOM since 2013.

Power

The NDRC also has the authority to approve certain investment projects in the power industry.

The Market Regulatory Department of the NEA (which took over from the State Electricity Regulatory Commission) regulates the power industry. It is responsible for the enactment and enforcement of regulations in this industry, and also for granting power business permits to power companies.

Other regulators

Other regulators include:

  1. the Ministry of Ecology and Environment (MEE): in charge of administering and enforcing environmental protection matters in China;
  2. the National Nuclear Safety Administration: an authority under the MEE that acts as the central government agency responsible for regulating nuclear safety and supervising all civilian nuclear infrastructure in China. It also inspects nuclear safety activities and regulates the project approval mechanism; and
  3. the Ministry of Emergency Management: responsible for overseeing and administering work safety nationwide.

iiLaws and regulations

The principle laws and regulations governing the energy sector include the following.

Oil and gas

  1. The Mineral Resources Law (1986, amended 1996 and 2009) and its Implementation Rules (1994) establish the basic legal framework under which exploration and production activities (including oil and gas development) are to be carried out.
  2. The Oil and Natural Gas Pipeline Protection Law (2010) provides for the security requirements for the construction and operation of pipelines.
  3. The Regulation on Registration of Exploitation of Mineral Resources (1998, amended 2014) provides detailed requirements on the registration of mineral resources exploitation and the issuance of exploitation licences.
  4. The Measures for the Administration of Transfer of Mineral Exploration Rights and Exploitation Rights (1998, amended 2014) regulate the transfer of exploration rights and exploitation rights.
  5. The Regulation on Sino-foreign Cooperation in the Exploitation of Onshore Petroleum Resources (1993, amended 2001, 2007, 2011 and 2013) is the basis for foreign companies to participate in the exploration and exploitation of onshore blocks in China through PSCs.
  6. The Regulation on Sino-foreign Cooperation in the Exploitation of Offshore Petroleum Resources (1982, amended 2001, 2011 and 2013) is the basis for foreign companies to participate in the exploration and exploitation of offshore blocks in China through PSCs.
  7. The Measures for Regulation of Fair and Open Access to Oil and Gas Pipeline Facilities (for Trial Implementation) (2014) (Third-party Access Measures) provide the third-party access regime, allowing third parties to use the surplus capacity of pipeline facilities.2
  8. The Measures for the Administration of Natural Gas Pipeline Transportation Prices (for Trial Implementation) (2016) provide that the pipeline transportation price is determined by the price administration department under the State Council following the principle of ‘allowed cost plus reasonable profits’.
  9. The Measures for the Supervision and Review of Natural Gas Pipeline Transportation Pricing Costs (for Trial Implementation) (2016) provide that the price administration department under the State Council shall be in charge of the supervision and review of pipeline transportation pricing cost following the principle of legality, the principle of relevance and the principle of rationality.
  10. The Guiding Opinions on Strengthening Regulations over the Gas Distribution Price (2017) provide that gas distribution price shall be determined and reviewed separately, following the principle of ‘allowed cost plus reasonable profits’.
  11. The Opinions regarding Further Reform of Oil and Gas Regime (2017). This ‘Opinions’ document was issued by CCP Central Committee and the State Council, and was long expected to set out a roadmap for the next phase reform in the oil and gas sectors. However, the full text of the document is not yet available in the public domain.
  12. The Regulations on the Administration of Assignment of Mining Right (Draft for Comment) (2019). This draft regulation was issued by the MNR, emphasising the decisive role of the market in the transfer of mining rights.

Power

  1. The Electric Power Law (1996, amended 2009, 2015 and 2018) is the main legislation governing the electricity sector.
  2. The Circular on the Reform Plan for Power Prices (2003) sets out the targets for the power price reform and is followed by the Regulation on Feed-in Tariffs (2005), the Regulation on Power Sales Price (2005) and the Regulation on Transmission and Distribution Price (2005).
  3. The NDRC Notice on Pilot Reform of Transmission Tariff in Shenzhen (2014) and NDRC Notice on Further Reform of Transmission Tariff following the Zhongfa (2015) No. 9 Document (2015) regulate the ongoing transmission tariff reform.
  4. The Regulations on Electricity Regulation were issued in 2005 to strengthen and improve electricity regulation, focusing on maintaining the order of electricity markets and promoting the development of the electric power industry.
  5. The Administrative Regulations on Permits for the Power Industry (2005) focus on maintaining the order of the electricity markets and promoting the development of the electric power industry.
  6. The Opinions regarding Further Reform of the Electric Power Regime (2015) set out the plan for further reform.
  7. The NDRC and NEA Circular on Issuing Supporting Documents for Electric Power System Reforms (2015) provides implementation measures for the reform of the power regime.
  8. The NDRC and NEA Circular on Issuing Administrative Measures on Electricity Companies’ Entrance and Exit and Administrative Measures on Orderly Derestricting the Electricity Distribution Network Business (2016) provide opportunities for social capital to enter into the electricity distribution industry.
  9. The NDRC and NEA Circular on Orderly Derestricting the Power Generation and Consumption Plans (2017) provides plans for promoting electricity traded through market-based transactions.
  10. The NDRC and NEA Circular on Actively Promoting the Market-oriented Power Transactions and Further Improving the Trading Mechanism (2018) sets out the road map to remove restrictions over market players in respect of their participation in seeking market-oriented power transactions.

Renewables

  1. The Energy Conservation Law (2008, amended 2016 and 2018) aims to promote energy conservation.
  2. The Renewable Energy Law (2010) sets general principles on renewable energy.
  3. The NEA Notice on Facilitating the Development of Geothermal Power (2013) is aimed at promoting the development and utilisation of geothermal power.
  4. The NDRC Notice on Adjustment of Feed-in Tariffs for Onshore Wind Power and Photovoltaic Power Generation Projects (2017) provides for the feed-in tariff for onshore and offshore wind farms and solar energy projects.
  5. The Administrative Regulation on Guaranteed Purchase of Renewable Energy-generated Power in Full Amount (2016) sets out detailed rules to guarantee the purchase of renewable energy generated power (excluding hydropower).
  6. The Rules for Issuance and Voluntary Subscription of Green Power Certificate (for Trial Implementation) (2017) provide for the regime of issuing and free trading of green power certificates.
  7. The NDRC Notice on the Program for the Establishment of a National Carbon Emissions Trading Market (Power Generation Industry) (2017) sets out detailed plans for promoting the establishment of a national carbon emissions trading market based on the current regional carbon trading pilots regime.
  8. The Circular of the NDRC, the Ministry of Finance (MOF) and the NEA on Matters concerning Photovoltaic Power Generation in 2018 limits the scope and subsidies of the photovoltaic industry in China.
  9. The Circular of the NDRC and the NEA on Positively Promoting the Work on Subsidy-free Grid Price Parity for Wind Power and Photovoltaic Power (2019) aims to implement the subsidy-free policy to reduce subsidies in solar and wind sectors.

In addition, there are numerous regulations and rules enacted by various administrative authorities, to define specific procedures or particular issues with respect to the electricity sector under the framework of the principle law and regulations.

iiiRegulated activities

Oil and gas

Upstream oil and gas exploration and production activities are subject to exploration and exploitation licences issued by the MNR.

In the upstream oil and gas sector, foreign companies should partner with and enter into PSCs with legally designated national oil companies (for details, see Section II.iv).

Pipeline design and construction activities are subject to review based on criteria related to safety, environmental protection, optimal land use and economic feasibility. The construction of oil and gas pipeline networks must be approved by the NDRC or its local branches. The qualifications of the enterprises and personnel engaged in the design, installation, use and inspection of pipelines must be accredited by the General Administration for Market Regulatory or its local branch as the case may be.

A specific business permit is required to engage in storage or trading of crude oil, or wholesale, retail or storage of refined oil products.

Power

Power companies are required to obtain electric power business permits issued by the NEA. Electric power business permits are divided into three categories depending on the type of business:

  1. a power generation permit for power generation companies;
  2. a power transmission permit for power transmission companies; and
  3. a power supply permit for power supply companies (power supply business is defined to cover both distribution and sale of power).

A company applying for an electric power business licences must demonstrate that it has the financial capability and personnel with the required experience. In addition, power companies must obtain approval for each specific power project from relevant authorities and comply with environmental regulations to be issued with the electric power business licence.

Through an NEA notice issued in April 2014 and further amended in December 2016, the following type of generation projects enjoy a general exemption for a power generation licence:

  1. distributed generation projects registered or approved by the NEA;
  2. small hydropower stations with single-station generating capacity below 6MW;
  3. new-energy generation projects (such as solar, wind, biomass, ocean power and geothermal power) with generating capacity below 6MW;
  4. power projects with comprehensive use of heat and pressure by-products; and
  5. captive power plants without direct combustion of fossil fuel and that are dispatched by dispatching organisations at city level or below.

ivOwnership and market access restrictions

General foreign investment regime

For decades, the foreign investment ownership and access restriction regime was based on a Foreign Investment Industrial Guidance Catalogue issued jointly by the NDRC and MOFCOM; the latest version of which was issued in 2017 (the 2017 Catalogue).3 Foreign investment activities were divided into three categories: ‘encouraged activities’, ‘restricted activities’ and ‘prohibited activities’. Any activity or sector not listed in the catalogue is ‘permitted’. Those falling in the ‘encouraged’ category would benefit from streamlined approval procedures, tax breaks and other incentives.

In June 2018, after a three-year pilot programme in free trade zones, China rolled out to the entire nation the new ‘negative list’ approach in respect of foreign investment. Accordingly, the ‘restricted’ and ‘prohibited’ categories of the 2017 Catalogues are now replaced by the Special Administrative Measures for Access of Foreign Investment (commonly known as the ‘Foreign Investment Negative List’). There remains a separate negative list applicable to the FTZs with fewer restrictions, the last version of which became effective in July 2018.

On 15 March 2019, the long-expected Foreign Investment Law was passed at the National People’s Congress, which shows China’s determination to make bigger strides in economic liberalisation. The Foreign Investment Law will come into force on 1 January 2020 to replace the existing three pieces of legislations governing the Sino-foreign equity joint ventures, Sino-foreign co-operative joint ventures and wholly foreign-owned enterprises in China.

Oil and gas

The state has ownership over all mineral resources within the territory of China. Pursuant to the Mineral Resources Law, a licensing regime has been adopted and the MNR has the authority to grant exploration licences and production licences.

For conventional oil and gas exploration and production activities, the issuance of exploration licences or exploitation licences are subject to the approval by the State Council. There are only four ‘licensed’ companies, namely China National Petroleum Corporation (CNPC), China Petrochemical Corporation (Sinopec), China National Offshore Oil Corporation (CNOOC) and Shaanxi Yanchang Petroleum (Group) Co, Ltd (Yanchang Petroleum). Under this regime, conventional oil and gas exploration and production activities are not open to other investors in China. However, foreign companies can partner with licensed Chinese oil companies (only CNPC, Sinopec or CNOOC) through the PSC arrangement to invest in onshore and offshore exploration and production in China.

However, the door is gradually opening up for private investment. The first step is marked by pilot reform in Xinjiang province since 2015. Some local SOEs (such as Beijing Energy Holding Co., Ltd and Shenergy Company Limited) and a private company (Zhongman Petroleum and Natural Gas Group Corp Ltd) successfully obtained oil and gas exploration rights through public tendering process initiated by Xinjiang government in 2015 and 2017. Sinopec also has, on limited occasions, partnered with domestic private investors through PSC arrangement; however, the legality of this practice is in a grey area under the current regime. In March 2019, the Annual Report on the Work of the Central Government stipulates that the existing restrictions shall be further released to attract social capital investment into oil and gas exploration and exploitation sector.

Unconventional oil and gas are regulated in various ways. For coal-bed methane, exploration and exploitation generally follows the regime for conventional oil and gas as introduced above. There is more flexibility in other types of unconventional oil and gas. Domestic investors can explore and exploit unconventional oil and gas blocks if they hold relevant qualifications, or choose to establish a joint venture or cooperate with other qualified companies. For foreign investors, the Foreign Investment Negative List has removed the requirement on ‘joint venture or cooperation’ for investment into oil shale, oil sands and share gas since 2017, which means foreign companies can either partner with Chinese companies holding an exploration licence under a PSC, or establish a joint venture with a Chinese partner to bid for the licences directly. Owing to the continuing efforts towards deregulation, future opportunities are expected to be available for wholly foreign-owned companies.

The midstream oil and gas industry is dominated by NOCs. CNPC controls nearly all the long-distance pipelines in China, including the West-East Pipelines system. The CNPC website states that the CNPC owns and controls 68.9 per cent of the nation’s crude oil pipeline and 76.2 per cent natural gas pipelines by the end of 2017. In December 2015, CNPC consolidated a sprawl of pipeline operations in a single company with a registered capital of 80 billion yuan, aiming to improve efficiency and boost the value of the businesses. It was considered a step towards potential divestment in future, as well as a prologue to the government’s bigger plan to reform the energy regime in China. In March 2019, the Annual Report on the Work of the Government confirms that a national oil and gas pipeline network company will be established in China, which is to take over the main pipeline assets from the NOCs.

Construction of new imported LNG receiving terminals of capacity of 3 million tonnes and above is subject to central government approval. Most of the LNG terminals are owned and operated by the three NOCs (i.e., CNOOC, CNPC and Sinopec). In recent years, private entities as well as foreign entities have started to participate in this sector as well. As of the end of 2018, there are three small-scale LNG terminals in operation that have been established by private investment, and several in construction. See Section III.ii for details of third-party access to infrastructure.

The downstream oil and gas sector, including oil refinery, petrochemical production and gasoline retail businesses, is still dominated by NOCs, although it is generally open to private investment and foreign investments, subject to ordinary permitting procedures. In practice, it is less common for foreign-invested companies to obtain such licences, which in fact constitutes a hurdle for foreign investment to further expand its downstream oil and gas business. In February 2019, one subsidiary of Shell incorporated in Zhejiang was granted a refined oil wholesale licence, the first time such licence was granted to a wholly foreign-owned enterprise established by an international oil company.

Power

The main market players in the power industry include generation companies (among which the five large state-owned generators are China Huaneng Group, China Datang Corporation, China Huadian Corporation, State Energy Investment Corporation (through the recent merger of China Guodian Corporation and China Shenhua Group) and State Power Investment Corporation (through the recent merger of China Power Investment and State Nuclear Power Technology Corporation), two grid companies (namely, State Grid Corporation of China and China Southern Power Grid Co) and companies engaged in power engineering and construction business (such as China Energy Engineering Group Co and Power Construction Corporation of China).

The main opportunities for foreign investors in the power industry lie in the construction and operation of power stations with pioneering technologies and in the renewable energy sub-sector. Specifically, the following types of business in the power industry are ‘encouraged’ in the 2017 Catalogue (as updated by the Foreign Investment Negative List):

  1. construction and operation of ultra-supercritical power stations with single unit power of 600,000kW or more;
  2. construction and operation of power stations for heat-power co-generation units of back-pressure (extraction-back) type, heat-power-cool multi-generation units, and heat-power co-generation units of 300,000kW or more;
  3. construction and operation of power stations with large air-cooled generation units with single unit power of 600,000kW or more in regions suffering from water shortage;
  4. construction and operation of projects of power generation via integrated gasification combined cycle and other clean coal power generation projects;
  5. construction and operation of power generation projects with single unit power of 300,000kW or more that use fluidised bed boilers and coal gangue, middling, and coal slurry;
  6. construction and operation of hydropower stations for the primary purpose of power generation;
  7. construction and operation of nuclear power stations (the Chinese party must hold a controlling interest);
  8. construction and operation of new-energy power stations (including solar energy, wind energy, geothermal energy, tidal energy, wave energy and biomass energy); and
  9. construction and operation of a power grid.

It is worth noting that, although not specifically addressed in the Foreign Investment Negative List , the following types of projects are generally restricted, which applies to all (foreign or domestic) investors, pursuant to Interim Provisions on Construction Management of Small Thermal Power Units (1997) and the NDRC Guiding Catalogue for Industrial Structure Adjustments (2011):

  1. power plants utilising coal-fired and steam condensation thermal generator sets whose single generator capacity is 300,000kW or less and connected to small grids;
  2. thermoelectric power stations utilising coal-fired steam condensation and extraction thermal generator sets whose single generator capacity is 100,000kW or less and connected to small grids; and
  3. the above types of power plants (in the case of thermoelectric power stations, the capacity threshold is 200,000kW) connected to large grids.

vTransfers of control and assignments

The transfer of exploration rights and exploitation rights for mineral resources (including oil and gas) is subject to the approval of the MNR provided that the following conditions are satisfied:

  1. two full years have passed since the issue of the exploration licence, or the discovery of the mineral resources available for further exploration or exploitation in the exploration zone4; or one full year has passed since the exploitation enterprise began exploitation;
  2. the specified minimum input for exploration has been fulfilled;
  3. no disputes have arisen regarding the ownership of the exploration rights and exploitation rights;
  4. the exploration right usage fees, exploitation fees or any price for the exploration and exploitation rights have been paid; and
  5. a transferee of mineral exploration rights or exploitation rights should meet the qualifications of a mineral exploration right applicant or exploitation right applicant prescribed in the Measures for Area Registration Administration of Mineral Resources Exploration and Survey or the Measures for the Registration Administration of Mineral Resources Exploitation.

The MNR will determine whether to approve the transfer within 40 days of receipt of the application. The transfer will take effect as of the day of approval.

As mentioned above, in most cases, the rights for exploration and exploitation of oil and gas are held by the three NOCs, with whom the foreign investors would enter into a PSC. There is no regulatory requirement for transfer of participating interest under a PSC. Previously, any amendments to the PSC were required to be approved by MOFCOM. This requirement was abolished in 2013 and now only record filing with MOFCOM is required. In terms of operatorship, Chinese PSCs often provide that the consent of a foreign investor is required if the NOCs propose to take over the production operations before foreign contractors’ full recovery of the development costs. After the full recovery of the development costs incurred in accordance with the ODP of any oil or gas field within the contract area, the NOCs may, at any time, have the right to take over the production operations by giving a written notice to the foreign contractor.

Transfer of power generation units in operation requires a change to the power business licence, which needs to be approved by the NEA. The NEA will review if the requirements for granting the relevant licences are still satisfied.

iiiTRANSMISSION/TRANSPORTATION and DISTRIBUTION SERVICES

iVertical integration and unbundling

The State Grid and China Southern Grid control the electricity transmission and distribution networks in China, and are used to monopolise the supply of electricity by purchasing power from power generators at regulated feed-in tariff, and sell power at the regulated power sales prices.

The ongoing power price reform, however, aims to separate the sale of power from grid companies. The Opinions regarding Further Reform of the Electric Power Regime (2015) and the NDRC and NEA Circular on Issuing Supporting Documents for Electric Power System Reforms (2015) provide that power generators will enter into agreements directly with retailers or users with term contracts or spot trades, with the power price being freely negotiated between the parties. The transmission and distribution tariff will be regulated by the government on a ‘cost plus reasonable profits’ basis. According to the Notice by the NDRC regarding Comprehensive Promotion of Pilot Reform of Transmission and Distribution Tariff (2016), this reform is now carried out in most provinces.

Since 2009, the user-generator direct trading system has been put on trial in more than 20 provinces. Companies with high electricity consumption (such as aluminium electrolysis and steel plants) can purchase electricity directly from generators. The price paid by such consumers is composed of the power purchase price negotiated between the generator and the consumer (under a power purchase contract), the transmission and distribution price paid to the grid company (under a service contract) and government surcharges. The Opinions regarding Further Reform of the Electric Power Regime (2015) also set out further goals for the development of this user–generator direct trading system.

iiTransmission/transportation and distribution access

Oil and gas

In 2014, China started a five-year trial period for the third-party access scheme in the oil and gas midstream infrastructures. In addition, the Regulation on Construction and Operation of Natural Gas Infrastructure (2014) encourages investment into natural gas facilities.

Under the Third-party Access Measures, pipeline and facility operators should grant third parties access to pipeline networks and associated facilities if operators have surplus capacity and, in the case of multiple third-party users, non-discrimination principles should apply, but priority should be given to contracts already in place. The facilities to be opened to third parties include not only trunk pipelines and branch pipelines for crude oil, refined oil and natural gas, but also the relevant associated facilities including ports, receiving terminals, and liquefaction, compression and storage facilities. However, there are various issues jeopardising the implementation of the open-access scheme. One of these is the lack of a clear definition of ‘surplus capacity’, and there is no clear mechanism to determine it. As a result, the five-year trial period came to an end in February 2019, during which a very limited number of facilities have been opened for third-party access.

In August 2018, the NDRC issued the draft version of Measures for Regulation of Fair and Open Access to Oil and Gas Pipeline Facilities for public comment (the 2018 Third-party Access Measures), which has not been finalised. This was followed by an announcement in March 2019 that a national pipeline network company is to be established. On the LNG terminals, following a couple of trial runs in late 2018, the CNOOC announced in March 2019 that it is preparing to open up its LNG terminals to third parties for a 10-year term contract via public auction, in a joint effort with the Shanghai Petroleum and Natural Gas Exchange. It remains to be seen how this regime will be developed further in the near future.

Power

A grid operator must ensure non-discriminatory and fair access of its grid to qualified power plants and disclose the following information to power plants within its network:

  1. grid structure and line layouts;
  2. amount and status of transformation facilities;
  3. total installed capacity;
  4. power supply and demand and transmission capacity of major lines and outgoing lines; and
  5. tariffs and prices for inter-provincial power transactions and direct trading.

An interconnection agreement will be entered into by the grid operator and the power generator, specifying terms and conditions including capacity and feed-in tariff.

Grid companies must ensure non-discriminatory and fair access to their grid to qualified power plants.

For renewable power generation (RPG) enterprises, the grid operators are required to:

  1. build and manage the interconnection system for qualified RPG projects;
  2. enter into grid connection agreements with qualified RPG enterprises; and
  3. purchase all the on-grid power generated by these RPG projects at a higher feed-in tariff.

iiiRates

Oil and gas

According to Measures for the Administration of Natural Gas Pipeline Transportation Prices (for Trial Implementation) (2016) and Measures for the Supervision and Review of Natural Gas Pipeline Transportation Pricing Costs (for Trial Implementation) (2016), inter-provincial pipeline transportation tariffs are regulated by the NDRC on the ‘allowed cost plus reasonable profits’ basis. The NDRC completed the costs assessment of 13 interprovincial pipeline systems in August 2017 and published reduced tariffs effective from September 2017. Such tariffs were adjusted in March 2019 to reflect the reduced VAT rates. Intra-province pipeline transportation tariffs are regulated by local development and reform commission and are reported to the NDRC annually.

According to the NDRC Circular on Issuing the Guiding Opinions on Strengthening Regulations over the Gas Distribution Price (2017), gas distribution price shall be determined and reviewed separately, following the principle of ‘allowed cost plus reasonable profits’. This marks a further big step by the state to achieve the goal of ‘regulating middle while liberalising the front and end’.

Power

In theory, the rates that the grid companies charge end users seek to recover power purchase costs and fees for transportation, distribution and sale services, power losses and the like. However, in practice, the rates are set by the government and vary depending on the type of user and the region.

ivSecurity and technology restrictions

Oil and gas pipeline owners and operators have obligations under the Oil and Natural Gas Pipeline Protection Law, including those to patrol, inspect and maintain the pipelines; to upgrade, transform or stop using those pipelines that do not satisfy the safe use requirements in a timely manner; to post, repair or change signs related to the pipeline; and to take effective safety protection measures for a pipeline not in operation.

As gas pipelines are considered to be ‘specialised equipment’ under the specialised equipment regulatory regime, a pipeline operator is required to hold a Specialised Equipment Registration Certificate. In addition, both natural gas and gas pipelines are considered to be ‘hazardous material’ under the hazardous material regulatory regime. The ‘producer’ of hazardous material is required to hold a Production Safety Permit and the ‘trader’ of hazardous material is required to hold a Hazardous Material Operation Permit. However, it is not clear whether the pipeline owner and operators will be considered producer or trader of hazardous material.

Power grid operators also have security obligations under the Electricity Law. The power grids shall be operated in accordance with the principles of safety, high quality and economy. Power grid operations must be maintained in an uninterrupted and stable way, with a stable supply of electricity guaranteed.

IVENERGY MARKETS

iDevelopment of energy markets

The price of refined oil products is regulated by the NDRC. Gas (including LNG) price used to be heavily regulated by the NDRC, but there has been a steady progress of deregulation. According to an NDRC press release, as of October 2017, the price for 50 per cent of all gas consumption in China was completely deregulated, 30 per cent was regulated on base-price basis, and the remaining 20 per cent was for residential use and the price was set by the government. In May 2018, the NDRC issued the Circular on Adjusting the Local Gate Station Prices for Natural Gas for Residential Use, which unified the pricing mechanism for residential and non-residential gas, allowing prices to rise by no more than 20 per cent from a benchmark price and drop to a level agreed by suppliers and purchasers. On 5 September 2018, the State Council issued several Opinions on Promoting the Coordinated and Stable Development of Natural Gas, in order to support the development of strategies on the comprehensive development of the natural gas industry. More supporting policies are expected to be issued in 2019.

In respect of electricity, under the current regime, grid companies purchase power from power-generation companies at regulated fixed prices and sell power to the customers at regulated fixed prices. Generation is dispatched on a fair and equal basis. Under the ongoing power price reform, the Chinese government is exploring the possibility of opening up electricity markets. The aim at this stage is to establish a mid-to-long-term market and a spot market.

iiEnergy market rules and regulation

Oil and gas

To engage in crude oil storage or trading, or refined oil wholesale or retail, a specific business permit issued by MOFCOM is required. There are certain requirements for applicants to obtain a business permit, including a certain amount of registered capital, long-term supply agreements, and stable sales channels and facilities. Foreign-invested enterprises may also apply for permits.

State trading enterprises and non-state trading enterprises may engage in the importation of crude oil and refined oil. MOFCOM publishes a list of state trading enterprises, and companies outside that list may become a non-state trading enterprise if they:

  1. have a foreign trade business qualification;
  2. satisfy the requirements published by MOFCOM; and
  3. register with MOFCOM.

Both state trading enterprises and non-state trading enterprises must obtain an import licence issued by MOFCOM. However, non-state trading enterprises shall be subject to import quotas. This quota for the year 2019 is 202 million tonnes for crude oil. In 2015, MOFCOM issued a notice setting out the detailed requirements for refineries to import crude oil, including requirements regarding equipment, product quality, safety management and personnel.

Use of imported crude oil was previously limited to NOCs. In February 2015, the NDRC issued a notice breaking the monopoly. Local refineries can now apply to use imported crude oil if they meet certain requirements, including requirements regarding equipment, product quality and safety management. Forty refineries have obtained a permit from the NDRC to use imported crude oil as of November 2018.

There is no market entry restriction on the import or export of gas or LNG.

In addition, trading of oil and gas requires safety permits under, for example, the hazardous material regulatory regime.

Power

Sale of power to customers has been largely controlled by the State Grid and China Southern Grid through their subsidiaries. Under the power sector reform, however, we expect to see more participants in the market. Apart from the user–generator direct trading system, the NDRC and NEA Circular on Issuing Supporting Documents for Electric Power System Reforms (2015) also allows independent power supply companies to participate in the market provided that certain conditions, including on total assets, equipment and expertise, and the electric power business licence issued by NEA, are met.

iiiContracts for sale of energy

Oil and gas

There are two types of government regulated prices:

  1. government fixed price; and
  2. government guidance price.

The former is fixed and there is no flexibility, while the latter is more flexible. Government guidance price can be in the form of:

  1. a benchmark price with a float range;
  2. maximum price;
  3. minimum price;
  4. the rate of price difference; and
  5. the profit rate.

When a foreign company invests in upstream oil and gas through the PSC regime, parties would normally agree in the PSC that the NOC will sell the foreign investor’s share of oil and gas on its behalf. Usually the price is determined by reference to the prevailing price in an arm’s-length transaction for a long-term sales contract of similar quality of crude oil in the main world oil markets with adjustment to be made for quality, delivery, transportation, payment and other terms, and expressed as ‘free on board’ price at the delivery point in China.

Upstream crude oil prices and gas prices are not regulated, while refined oil prices and natural gas prices at city gate are subject to government regulation:

  1. the retail and wholesale of gasoline and diesel, as well as sale of gasoline and diesel to wholesale business, railway customers and transportation customers are subject to the governmental guidance price; and
  2. the supply of gasoline and diesel for state reserves or Xinjiang Production and Construction Corps as well as the factory price of aviation gasoline are subject to government (fixed) pricing.

The price of gasoline and diesel will be adjusted every 10 business days based on international crude oil price, processing cost, taxes, transmission fees and reasonable profits.

The government provides for base price of natural gas at the city gate (which means parties may negotiate the city gate price and such price shall not exceed 120 per cent of base price) while the ex-factory price can be negotiated between parties. The prices of gas produced from shale gas, coal-bed methane, coal gas and imported LNG are deregulated and can be determined by parties. The price for direct sale arrangement between CNPC/Sinopec and industrial users under ‘direct supply arrangement’ is also deregulated. In order to accelerate the gas price reform, the state started a pilot programme in Fujian province in November 2016, whereby the city gate prices will be determined freely based on negotiation between the supplier (CNPC) and consumers (utilities), and not subject to government regulation.

Power

To a large extent, the power prices are set by the government, taking into account the power purchasing cost, the loss from power transmission and distribution, power transmission and distribution price and government funds. The prices vary depending on a number of factors including season, peak hour, region and type of user (namely, residential user, agricultural user and industrial and commercial user).

Customers are allowed to participate in the power market if certain criteria are met, and may choose to enter into power purchase agreements with (1) power supply companies, or (2) directly with power generators. The terms and conditions of these agreements can be freely negotiated between two parties.

The Opinions regarding Further Reform of the Electric Power Regime (2015) and the NDRC and NEA Circular on Issuing Supporting Documents for Electric Power System Reforms (2015) set out future steps to further facilitate the reform, including determining qualified generators based on energy conservation and environment protection requirements; expanding the direct trading to power supply companies; and encouraging long-term agreements between generators and customers.

The NDRC and NEA issued the Circular on Actively Promoting the Market-oriented Power Transactions and Further Improving the Trading Mechanism in 2018, which stipulates a further increase in the scale of market-oriented trading power trading, the speed of development of power consumption plans, the scope of market entities, and the active promotion of the participation of various market entities in power market transactions.

VRENEWABLE ENERGY AND CONSERVATION

As part of government policies in response to climate change and in line with China’s commitments to the international community, the State Council set an objective to control energy consumption to 5 billion tonnes of standard coal in the 13th Five-Year Plan period (2016 to 2020). The NDRC also set Mid-to-Long Term Plans for renewable energy development: 10 per cent of the total energy consumption should be sourced from renewable energy by 2010, and 15 per cent by 2020. The midterm target (10 per cent by 2010) has been achieved. In July 2017, the NEA issued Guidelines of the National Energy Administration on the Implementation of the 13th Five-Year Development Plan for Renewable Energy, listing the overall development plan for wind power, biomass and solar plants for 2017–2020.

In addition, the Chinese government has established a clean development mechanism fund to support construction and industrial activities that are beneficial to strengthen proper responses to climate change since 2010. The construction and operation of power stations using renewable energy is ‘encouraged’ under the 2017 Catalogue.

Under the current power regime, the government sets higher feed-in tariffs (FITs) to encourage power generation from renewable energy. The tables below set out the latest policy on feed-in tariffs for wind, biomass and solar power.

Wind and biomass

Electricity source FITs
Wind Onshore project: four tiers ranging from 0.4 yuan/kWh to 0.57 yuan/kWh, depending on project locations (for projects approved after 1 January 2018 and projects approved before 1 January 2018 but not in construction at the end of 2019).
Offshore projects: 0.85 yuan/kWh or 0.75 yuan/kWh depending on the distance to shore.However, for the 2019 newly approved centralised onshore wind power projects and offshore wind power projects, feed-in tariffs shall be configured and determined through competition, as per the Notice on the Relevant Requirements for Wind Power Construction Management in 2018 issued by the NEA.
Biomass 0.75 yuan/kWh.

Solar

Resource area Centralised PV
Feed-in tariff
Distributed PV
Subsidy payments
General Poverty alleviation projects General Poverty alleviation projects
Class I regions 0.55 yuan/kWh 0.65 yuan/kWh 0.37 yuan/kWh 0.42 yuan/kWh
Class II regions 0.65 yuan/kWh 0.75 yuan/kWh
Class III regions 0.75 yuan/kWh 0.85 yuan/kWh
1. The PV power plant feed-in tariff in Tibet is 1.05 yuan/kWh.
2. The FIT and subsidies for PV projects are decreasing over the years, and the rates above are applicable to new projects to be subsidised through the annual quota system from 2018 onwards.

Other incentives include:

  1. surcharges collected from all electricity end users are used to subsidise the difference between feed-in tariffs and the benchmark price for desulfurised coal generators, operations and maintenance for independent public power systems, and costs for connecting renewable energy generators to power grids;
  2. favourable loans with financial discounts for renewable energy projects listed in the guidance catalogue for renewable energy industry development;
  3. subsidies for renewable energy development in areas such as new-energy vehicles, building-integrated solar photovoltaic systems, wind turbines and biomass power generation; and
  4. tax incentives.

However, it is worth noting that the Action Plan (2014–2020) for Energy Development Strategy marks a concerted shift to a more market-driven approach to future build out in China. To implement such plan, the Circular on Photovoltaic Power Generation (2018) and the Circular on Positively Promoting the Work on Subsidy-free Grid Price Parity for Wind Power and Photovoltaic Power (2019) were issued to gradually reduce subsidies in the solar and wind sectors.

After Fukushima, the NDRC approved a nuclear project in March 2015 marking the official relaunch of nuclear projects in China. The Mid-to-Long Development Plan of Nuclear Power by the State Council sets the target for nuclear power at installed capacity of 58 million kW and 30 million kW under construction by 2020, which means a shortfall of 39 million kW. The industry was expecting a large wave of investment into nuclear power in the near future. In January 2019, two units of Zhangzhou Nuclear Project Phase I (jointly invested by China National Nuclear Corporation and China Guodian Corporation) and two units of Huizhou Taipingling Nuclear Project Phase I (invested by China General Nuclear Power Corporation) were finally approved by the State Council, which marked the end of three-year period during which no new nuclear projects were approved. In early April 2019, NDRC issued a new circular providing that first batch of third-generation nuclear power projects shall apply feed-in tariff on a case-by-case basis.

In order to help reduce government subsidies to the renewables sector, the NDRC, together with the Ministry of Finance and the NEA, issued a Circular on the Trial Implementation of the Renewable Energy Green Power Certificate Issuance and Voluntary Subscription Transaction System (the Green Power Certificate Circular) in January 2017. According to the Green Power Certificate Circular, solar and wind power producers would apply for and be issued tradeable certificates for the renewable electricity generated by them. End users are encouraged to buy such certificates at an agreed price through negotiation or a bidding process. Solar and wind power producers will not receive a direct subsidy (higher FITs) for the electricity corresponding to the certificates sold. In July 2017, an official website for trading of the Green Power Certificate was launched. As of March 2019, while over 25 million certificates were issued, only around 33,000 certificates were traded.

Also aiming to promote clean energy, a carbon emissions trading system has been operated on a pilot basis in parallel. In December 2017, the NDRC announced the plan to roll it out to the national level. The interaction and reconciliation between the green certificate regime and the carbon emissions trading system are to be further observed in the future.

ViTHE YEAR IN REVIEW

In February 2017, the State Council released the 13th Five Year Plan for Energy Development (2016 to 2020), listing future energy strategies for an efficient, clean and safe energy system. According to the Plan, the annual primary energy consumption will be capped at an amount equivalent to 5 billion tonnes of standard coal by 2020. The Plan sets goals on future energy structure, with at least 15 per cent of energy supplied from non-fossil fuels, 20 per cent supplied from natural gas and at most 58 per cent from coal by 2020.

China continues towards achieving the marketisation of its energy supply. Gas price deregulation is the most advanced in progress compared to other sub-sectors. In May 2018, China unified the pricing mechanism for residential and non-residential gas, a long expected milestone in the pricing reform roadmap. The deregulation of gas price coincides with a jump in gas demand. In 2018, the total gas consumption increased to 280 billion cubic metres. 53 per cent of the gas supply comes from importation of LNG. China has become one of the most active natural gas and LNG markets in the worldwide.

In 2018, China intends to streamline and further open up its oil and gas industry. Despite the oil and gas exploration and exploitation business is denominated by NOCs, China is now trying to encourage social capital into the upstream business. The plan on establishment of the national oil and gas pipeline network company which is expected to attract private investment marks one of the essential steps in separation of transmission businesses. The shooting demand on LNG supply attracts more and more interests from private investors and foreign investors to develop LNG receiving terminals in China.

Electricity market reform is ongoing. The year of 2018 witnesses the launch of pilot spot market trading in Guangdong, Gansu and Shanxi. The market-oriented electricity trading is pushed by the central government through new policy encouraging direct sales arrangement and participation of more diversified market players. In renewable sector, China decided to tap the brakes for fast-growing wind and solar industry through a reduction of subsidies. Resumption on nuclear power projects also shows the government’s determination to diversify the supply of energy.

In March 2019, the Foreign Investment Law was promulgated amid the trade war between China and the US. The law aims to provide a level playing field for foreign investment into China, including in particular the national treatment for foreign investors in all business activities other than those specifically set out in the Foreign Investment Negative List. As a piece of policy-driven legislation, it only contains around 40 clauses with general and broad terms; some of the more controversial operative provisions, which were considered and debated in earlier drafts, were left out. It remains to be seen how the new law will be implemented in practice, and how it will coordinate with and promote the further opening up of energy markets in China.

ViiCONCLUSIONS AND OUTLOOK

The regulatory environment is changing fast in China, and the energy sector is no exception. Both the economic restructuring plan and the development of green-energy technology have had a profound influence on the energy industry. Various stakeholders and their demands contribute to innovation in the industry, while also adding complexity to the reform process. With reforms taking place in the regulatory regime and the restructuring of the market ongoing, it is vital to keep a close eye on energy regulations in China.


Footnotes

1 Monica Sun is a partner, James Zhang is a senior associate and Qiujie Tan is an associate at Herbert Smith Freehills LLP.

2 It is worth noting that this legal document is under review by the NDRC. NDRC has issued Draft Measures for Regulation of Fair and Open Access to Oil and Gas Pipeline Facilities for public comments in 2018.

3 It is worth noting that the Catalogue of Industries for Encouraged Foreign Investment (Draft for Comment) was issued in February 2019. The format of the 2019 Draft Encouraged Catalogue consists of two regional lists: one for every region of China and another for the central and western regions (the latter list is only applicable for investments into central and western regions, north eastern regions and Hainan Province). If enacted, the 2019 Draft Encouraged Catalogue will increase the number of sectors open to foreign investment, especially in the fields of high-tech manufacturing, artificial intelligence, intelligent technology for health advancement, recycling or environmentally friendly practices, and new agricultural practices.

4 MLR issued a notice in late 2017 which applies only to ‘minerals other than oil and gas’ (note that it is not clear whether oil sands or other types of unconventional oil and gas will fall into this category). For exploration rights acquired by ways of (1) prior application, (2) bidding, (3) auction, or (4) listing, (i.e., other than by ‘private agreement’), the conditions for transfer of exploration right shall include that two years have passed since the issue of the exploration licence, or one year has passed if a geographic report has been filed for recordation after reserve assessment at or above the general survey level. In case where the exploration right was acquired by ‘private agreement’, then ten years shall have passed, otherwise, the requirements and procedures for a new ‘private agreement’ shall apply to such transfers.