China’s National Energy Administration (“NEA”) released the Measures for Regulation of Fair and Open Access to Oil and Gas Pipeline Networks (“Measures”) on 13 February 2014, which sets out the rules for third party access to the country’s networks of oil and gas pipelines and associated facilities, both onshore and offshore. TheMeasures are a trial version with a validity period of 5 years. Revisiting progress and further rules are envisaged in the future.

 

1. Background

 

China’s midstream oil and gas industry has been dominated by certain Chinese state-owned enterprises (SOEs), in particular China National Petroleum Corporation (CNPC) which controls nearly all the long-distance pipelines in China, including the West-East Pipeline. This monopolistic position in midstream activities has been criticised, but there was no separate regulatory framework for midstream. The Law on Protection of Oil and Natural Gas Pipelinespassed in June 2010 specifies regulation on pipeline construction and operation, but does not provide how access to transportation system is organized.

 

The passage of the Measures could mean a significant step to open pipeline networks and facilities and boost the incentives for third parties to develop the country’s oil and gas reserves. However, it remains to be seen how it will operate in practice.

 

2. Key points of the Measures

 

The Principles

 

The Measures provide that pipeline and facility operators (“Operators”) must equally open pipeline networks and associated facilities to third parties and provide transportation, storage, gasification, liquefaction and compression and other services (“Services”), if they have surplus capacity.

 

Where there are multiple users of the pipeline networks and associated facilities, Operators must open the access to users on an equal basis without discrimination, but giving priority to contracts in place (and where more than one, based on the date of signing chronologically).

 

Pipeline Networks And Associated Facilities

 

The facilities to be opened 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.

 

Third Parties

 

Under the Measures, third parties that are allowed to access the Operators’ pipeline networks and facilities include both upstream users and downstream users, both of which should be enterprises registered in China. Therefore, foreign invested enterprises are generally eligible to apply for open access, but a foreign investor without a registration in China will not be eligible.

 

• “Upstream Users” are regarded as oil and gas (including crude oil, refined oil, natural gas, CMG, CBM and shale gas) production enterprises and upstream oil and gas trading enterprises;
• “Downstream Users” are regarded as downstream oil and gas trading enterprises and end users (including city gas enterprises, retail enterprises and refineries, power plants, industrial users and other users).

 

Both Upstream Users and Downstream Users (collectively “Users”) are encouraged to enter into oil/gas sale and purchase agreements directly with each other, and enter into a services agreement with an Operator.

 

The Process For Access

 

Pursuant to the Measures, there will be a two-step process for obtaining access to pipeline networks and facilities from Operators:

 

• Application: a User should apply to an Operator for access, with supporting documentation including:
  • for an Upstream User, oil and gas development/production status and forecast, a production capacity report verified by suitably qualified third parties, specifications of the oil/gas product, quantity and period of Services;
  • for a Downstream User, facility safety design, fire safety design, sales report of last three years in months and end users, demand forecast, oil/gas quality requirements, quantity and period of Services.

 

The Operator will decide in 30 business days whether or not to grant access. If it decides not to grant access, it must explain the grounds for its decision and copy such opinions to the NEA or its local branches.

If a refusal of access is disputed, the User may, within 30 business days of receipt of the opinion, request the NEA or its local branches to “coordinate” arrangements. The time for NEA’s coordination is not specified.

 

• Contracts: where the Operator decides to grant access, the parties must enter into a service agreement (according to the NEA, it is in the process of promulgating standard form service agreements). Service agreements should be filed at the NEA or its local branches by the Operator annually.

 

Quality, Measurement And Price

 

The Measures also provide that quality of the oil and gas being transported, stored, gasified, liquefied or compressed should meet a national quality standard, and measurement should be carried out in accordance with relevant laws and regulations.

 

The price for Services will be determined by the pricing authorities of the Chinese government. However, currently there is no unified legislation in relation to oil and gas services pricing. To our knowledge, the current price for pipeline transportation of crude oil is set by National Development and Reform Commission (“NDRC”) depending on the distance and diameter of the pipeline. The current price for pipeline transportation of natural gas is determined by provincial governments.

 

Transparency And Confidentiality

 

Operators will be required to publish information in relation to access standards, service price, conditions and procedures for application regularly, through their own website or other platform recognised by the NEA.

 

Operators should also disclose to the Users information in relation to the status of the facilities, the delivery points, outstanding capacity and scheduled maintenance. Users must keep such information confidential.

 

3. Comments

 

To Open Or Not To Open

 

Although the Measures mandate Operators to open their pipeline networks and facilities, there is much detail and practice to be clarified. In addition to uncertainty as to how the process will work in practice, it is worth noting that:

 

• Open access is conditional upon surplus capacity of Operators. However, “surplus capacity” is not defined in the Measures, nor is there a mechanism to determine whether there is “surplus capacity”.
• The conditions for access are still subject to the Operator’s discretion. Although Operators are required to publish information as mentioned above, it remains to see whether the information platform will be as transparent in practice as will be necessary.

• Although a refusal of access is to be copied to the NEA or its local branches, the Measures do not specify the power of the NEA to review or revoke the Operator’s decision.

 

Beneficiaries

 

Commentators have mentioned that China’s unconventional gas sector may benefit most from the Measures where many private companies involved in coalbed methane and shale gas currently have limited access to pipelines, while the oil sector may be less impacted because most of the oil industry is still controlled by the SOEs. However, how the private companies may be granted access largely depends on how neutrally the Operators will behave in allocating capacity. Although the Measures stipulate principles of “equal and fair” treatment “without discrimination”, there appears to currently be a lack of effective tools to prevent Operators prioritising affiliated Upstream or Downstream Users in reality. The role and position of the NEA is likely to be particularly important in this regard.

 

Fixed Price

 

The price for Services is required to follow the price determined by the Chinese government, but how pricing will be supervised remains unclear. Fixed price, as we have seen in the renewable electricity sector, could result in loss of profit margin for the market players, and Operators may have no financial incentive to open access.

 

Consequences For Non-Compliance

 

The Measures do not provide “hard” consequences for non-compliance, such as financial penalties. Article 25 only provides that the NEA may order rectification and issue a “notice of criticism” if there is non-compliance. It can also give opinions in relation to penalties for responsible personnel.

 

The NEA is likely to try to play a role of “coordination and mediation” where the relevant parties are in dispute during the enforcement of a service agreement. As such, how effective the NEA will be in exercising its power to oversee and “regulate” the market is to be tested in practice.

 

4. Looking Forward

 

China is pushing forward the liberalisation of its oil and gas sector. The promulgation of the Measures is among the first steps of such reform by the new leadership in China. Sinopec recently announced that it would allow private investors to participate in up to one third of its oil product trading segment. Whilst it will take time to evaluate the effectiveness and implementation of the Measures in practice; the 5-year “trial period” also indicates that there will be further review of progress and of the regulatory framework in the context of overall on-going industry reform.

 

 

For further information, please contact:

 

David Clinch, Partner, Herbert Smith Freehills

[email protected]

 

Hilary Lau, Partner, Herbert Smith Freehills

[email protected]

 

Monica Sun, Partner, Herbert Smith Freehills

[email protected]

 

Herbert Smith Freehills Energy & Project Finance Practice Profile in China