China: China Promotes Shale Gas Exploration

In recent years, China has gradually revised its investment policies, laws, and regulations with the aim of achieving sustainable and environmentally-friendly economic development. Important to this end, China has committed at a policy level to develop clean and unconventional domestic energy resources to fuel the country's expanding economy while easing its growing reliance on imported oil, natural gas, and liquefied natural gas (LNG). This China Practice Update briefly describes and analyzes recent Chinese legislative developments designed to encourage the commercial development of shale gas.

China Declares Shale Gas an "Independent Mining Resource" and Encourages Foreign Investment

In the past year, with input from the energy industry, the Chinese government has focused on finding ways to promote the exploration and development of shale gas and liquids. In June 2011, China issued its first shale exploration tender with an offer of four blocks to a group of six blue-chip stated-owned energy and mining companies. Although foreign energy companies were not permitted to participate directly in this first bid round, they are permitted to form joint ventures with and supply technology services to Chinese companies engaged in the exploration and production of shale gas and liquids. Most recently, at the end of 2011, Chinese policy makers took further steps to encourage foreign investment in the development of shale resources.

On December 24, 2011, China's National Development and Reform Commission (NDRC) and Ministry of Commerce (MOC) jointly issued a new, revised version of the Foreign Investment Industry Guidance Catalogue (the "Catalogue"), which took effect on January 30, 2012. The new Catalogue specifies that foreign investments in the exploration and development of shale gas and shale liquids in the form of a joint venture with a Chinese partner now falls under the "encouraged" category, which will entitle the foreign investor to certain tax and administrative benefits. For more information on the 2011 Catalogue, please see the client e-communication entitled "China Amends Foreign Investment Policy: New Foreign Investment Industry Guidance Catalogue".

This is a positive development for foreign energy companies that are interested in taking advantage of their know-how in shale exploration and development — in particular their experience with horizontal wells and fracturing or "fracking." The Chinese government has yet to clarify, however, whether foreign energy companies will be permitted to participate directly in future shale license bid rounds, rather than simply providing services to operators, and if so whether a foreign company may hold a majority participating interest and/or act as operator in the exploitation and development of shale gas blocks.

In a further significant legislative development, China's Ministry of Land and Natural Resources (MLR) announced on December 31, 2011, that China's State Council had approved changing the legal status of shale gas from a "natural resource" to an "independent mining resource."   

Prior to this announcement, shale gas had been considered a "natural resource" subject to China's Mineral Resources Law and its implementing rules which provide that only (i) oil companies established by approval of the State Council; or (ii) energy companies with State Council's special approval are permitted to apply for exploration and production rights of oil and natural gas in China. In addition, in accordance with the Regulations on Sino-Foreign Cooperative Exploitation of Offshore Petroleum Resources and the Regulations on Sino-Foreign Cooperative Exploitation of Onshore Petroleum Resource, only certain eligible Chinese state-owned oil and gas companies (i.e., CNPC, Sinopec, and CNOOC) are permitted to cooperate with foreign energy companies to explore for, develop, and produce oil and gas in China. As a result, foreign energy companies can only explore for, develop, and produce hydrocarbons in China if they partner with one of the Chinese state-owned oil and gas companies that is expressly authorized to cooperate with foreign energy companies. The MLR's announcement lifts this restriction for shale gas. By doing so, the MLR hopes to encourage faster development of China's unconventional resources by extending access to private oil companies to join in the shale gas exploration market.

According to news reports, the MLR will begin a second tender for shale gas block licenses in the near future and more than 10 blocks are expected to be up for bidding. MLR has recently indicated that qualified private energy companies may participate directly in the second tender. It is not clear at this time whether foreign energy companies will be allowed to bid in the next auction round for shale blocks; we understand that the MLR and other Chinese government agencies are discussing the issue.

Almost concurrently with the MLR designating shale gas as an independent mining resource, China authorized a pilot gas-pricing program for wholesale and retail natural gas prices in Guangdong and Guangxi provinces. The ultimate goal of this pilot program is to liberalize wellhead prices of natural gas and allow them to be guided by the market, while the government retains control over tariffs for the pipeline transportation of natural gas. For more information on the pilot program, please see the client e-communication entitled "China Initiates Pilot Reports for Natural Gas Pricing Systems in Guangdong and Guangxi". China's new gas-pricing pilot will help local producers and importers of gas while boosting domestic production.

Conclusion

The U.S. Energy Information Administration estimated in April 2011 that China could hold more than 36 trillion cubic meters of "technically recoverable" shale gas, which may be more than the known reserves in the United States. The preferential policies described in this practice update demonstrate China's desire to create a favorable and sustainable foreign investment environment in order to attract the advanced technology and know-how needed to develop the country's unconventional natural resources. Although foreign companies are not yet permitted to participate directly in China's domestic shale gas licensing round, they may provide technical services to Chinese companies. Further regulatory developments may be in the offing, creating opportunities for international energy companies as well as domestic Chinese private companies to participate in the Chinese oil and gas market in ways not possible before.

We will continue to follow these developments closely.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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