34455 Modernizing China's Oil And Gas Sector: Structure Reform and Regulation Consolidated Joint Report of the World Bank and the Institute of Economic System and Management November 20, 2000 CONTENTS Preface..................................................................................................................................i Executive Summary ...........................................................................................................iii Chapter 1: A Sector in Transition: China's Oil and Gas Sector Moving to a Market Economy..............................................................................................................................1 1.1 Background .........................................................................................................1 1.1.1 Sector Change and Legal Framework.........................................................3 1.2 Barriers to a Successful Transition......................................................................4 1.3 Policy Objectives.................................................................................................6 1.4 Key Areas for Comprehensive Reforms .............................................................7 1.5 Guidelines for Reform and Phased Implementation ...........................................8 Chapter 2: Creating a Competitive Sector Structure ..............................................10 2.1 Overview and Objectives ..................................................................................10 2.2 Corporate Governance and Ownership .............................................................11 2.3 Increased Upstream Exploration and Development..........................................11 2.3.1 Access to Petroleum Mineral Rights.........................................................11 2.3.2 Access to Markets .....................................................................................13 2.3.3 Introduction of Market Forces: Crude Oil Pricing, Allocation, and Competition...............................................................................................................15 2.4 Increased Downstream Oil Efficiency ............................................................166 2.5 Increased Downstream Gas Market Penetration...............................................19 Chapter 3: Regulatory Reform: Promoting Transparency, Investment, and Competition.......................................................................................................................24 3.1 Role of Regulation ............................................................................................24 3.1.1 The Nature of the Regulatory Body..........................................................25 3.1.2 Need for Regulatory Change.....................................................................25 3.1.3 Scope and Depth of New-Style Regulation...............................................26 3.2 Regulatory Framework: Principles to Drive Investment...................................27 3.2.1 Separation of Regulation from Policymaking...........................................27 3.2.2 Independent Regulatory Decisionmaking.................................................28 3.2.3 Removal of Policy and Regulatory Responsibilities from SOEs..............29 3.2.4 Transparent Regulation .............................................................................29 3.2.5 A Sound Legal Framework .......................................................................29 3.3 Proposals and Objectives for Sector Regulation...............................................31 3.3.1 Organizational Options .............................................................................31 3.3.2 Policy Issues to Be addressed....................................................................32 3.4 Transition Period...............................................................................................34 3.4.1 Organization and Relationships in the Transition Period..........................36 3.4.2 Required Studies to Prepare for Regulatory Change ................................38 3.5 Conclusions on Regulatory Reform..................................................................39 Chapter 4: Summary: Challenges and Phased Implementation..............................41 4.1 Major Challenges ..............................................................................................41 4.2 Need for Transition and Legal Framework.......................................................41 4.3 Making a Start: Regulation of the Downstream Gas Industry..........................42 4.4 Implementation and Road Map.........................................................................43 Annexes 1 List of Experts that Participated in the Work Group Meetings 2 A Comparative Analysis of the Upstream Fiscal Terms for China 3 Market Opening and Security of Oil Supply 4 "Qualification" or "Certification" of Participants in Oil and Gas Operations 5 A Comprehensive Listing of Proposed Regulatory Activity 6 Environmental Regulation 7 International Cases of Structural and Regulatory Reform Tables 1.1 Primary Energy Production and Consumption, 1990­99 (mtoe) 3.1 Regulatory Areas during Transition, 2000­05 3.2 Regulatory Areas after Markets Are Functioning, Post 2005 4.1 An Illustrative Five-Year Road Map: Policy, Structure, Regulation, and Legislation Figures 1.1 Changing Structure of Primary Energy Consumption 1.2 Growing Import Supply Gap Boxes 2.1 Sector Reform Actions: Access to Petroleum Mineral Rights 2.2 Sector Reform Actions: Access to Markets 2.3 Sector Reform Actions: Pricing, Allocation, and Competition 2.4 Increased Downstream Efficiency 2.5 Increased Downstream Gas Penetration 3.1 Principles of Independent Regulation 3.2 Summary of Organizational Actions for 2000 ACRONYMS AND ABBREVIATIONS AEUB Alberta Energy and Utilities Board CNOOC China National Offshore Oil Company CNPC China National Petroleum Company E&D Exploration and development EU European Union GOC Government of China IOC International oil company IPO Initial public offering LNG Liquefied natural gas LPG Liquefied petroleum gas MOPI Ministry of Petroleum Industry OECD Organization for Economic Co-operation and Development OLADE Organization of Latin American Energy R/P Reserves-to-production ratio PSC Production-sharing contract SAPCI State Administration for Petroleum and Chemical Industries SEPA State Environmental Protection Administration SINOCHEM China Chemical Industry Import/Export Corporation SINOPEC China Oil and Petrochemicals Company SOE State-owned enterprise SDPC State Development Planning Commission TOR Terms of reference WTO World Trade Organization UNITS OF MEASURE Bcm Billion cubic meters b/d Barrels per day mtce Million tons of coal equivalent mtoe Million tons of oil equivalent Modernizing China's Oil and Gas Sector: Executive Summary Page i PREFACE This is a joint report prepared by the World Bank and the Institute of Economic System and Management, the State Council Office for Restructuring the Economic System, People's Republic of China. With a view to promoting the research on the regulatory framework for the Chinese oil and gas sector, energy experts from the World Bank and its Chinese counterpart team, whose core membership was drawn from the Institute, formed the joint working group. In addition to experts from the Institute, officials and experts from the Ministry of Land and Resources, State Administration for Petroleum and Chemical Industry, PetroChina Company Limited, China Oil and Petrochemicals Company (SINOPEC), and the China National Offshore Oil Company (CNOOC) also participated in the joint work. As well, there was participation, where necessary, by government officials and experts relevant to oil and gas matters. The World Bank energy experts made three visits to Beijing in September and November­December 1999 and in April 2000, during which the Chinese members from the joint group worked closely with the World Bank experts. Three reports were drafted during the first two missions. They were carefully reviewed by the Chinese counterparts who then recommended corrections. The World Bank experts modified these reports according to the Chinese counterparts' opinions. It was on this basis that the final report was drafted and completed jointly by the Word Bank and the Institute. The working staff of the World Bank highly commended the Chinese counterparts' work; the Institute was most appreciative of the World Bank experts' effort, ingenuity, and efficiency. At the same time the two sides are sincerely appreciative of the active cooperation of all other parties concerned. The feedback and comments provided by experts from these institutions were very helpful and resulted in improvements to the report. At the same time, it is recognized that the points of view expressed in this report may not be consistent with the opinions of all of the different institutions that were consulted. List of the Joint Working Group Group Leaders: World Bank: Noureddine Berrah Task Team Leader, Energy Program Coordinator, World Bank Institute: Chen Li Executive Deputy Director Members: World Bank: Modernizing China's Oil and Gas Sector: Executive Summary Page ii Bent Svensson Lead Energy Economist Elaine Sun Energy Program Coordinator, World Bank, Beijing Ralf Dickel Sr. Gas Specialist Roland Priddle Consultant Tom Houston Consultant Peter N. Cameron Consultant Robert McManus Consultant Dean Girdis Consultant Institute of Economic System and Management, Office of Restructuring the State Council: Huan Guoyu Office Director, Professor He Xiaoming Professor Li Xiaodong Associate Professor Wang Jianmei Deputy Division Chief Gao Shiji Associate Professor Ministry of Land and Resources Che Changbo Director, Department of Geological Exploration State Administration for Petroleum and Chemical Industries (SAPCI): Liu Yan Division Chief, Petroleum Division, Planning Department China National Petroleum Company (CNPC): Jiang Lixin Deputy Economist General, Secretariat of the Board of Directors SINOPEC: Zhang Xuzhi Team leader of Strategic Research Team Fang Zhongyu Team member of Strategic Research Team China National Offshore Oil Company (CNOOC): Liang Zhili Advisor, Legal Department Zhou Shengwei Division chief, Office for Restructuring the Economic System The list of experts who participated in the Working Group meetings is attached as Annex 1. Modernizing China's Oil and Gas Sector: Executive Summary Page iii EXECUTIVE SUMMARY THEME I: Much progress has been achieved in restructuring the oil and gas sector but the piecemeal and administered market approach has now reached its limits. 1. In China's coal-based economy, oil meets about 20 percent of primary energy consumption needs and natural gas about 2 percent. The energy sector has grown rapidly, but is still relatively underdeveloped. Thus, per capita consumption is low by international standards (0.9 tons oil equivalent, compared with 4.0 for Western Europe, but 0.6 for the rest of Asia) and so is the share of fluid fuels (oil and gas together), which is well over 50 percent for many developed economies. 2. Oil production, mostly from northern China, of about 160 million tons annually, supplies some 80 percent of national requirements, but imports are now growing rapidly because of an accelerating shortfall against domestic consumption. Gas production has been rising more than oil, but despite the Government of China's (GOC's) stated objective of raising it to 6 percent by 2010, the share of gas in the energy balance is still very low, even compared with neighboring East Asian countries that use imported liquefied natural gas (LNG). The reserves-to-production ratio (R/P) for oil (14) suggests a lack of effective upstream investment. The ratio for gas (40) is rather high, compared with industrial consuming countries, denoting insufficient investment in downstream market development. 3. Much progress has been made in areas such as oil production, the development of national technical capability, oil products exports, and the ability to attract foreign capital through production-sharing contracts (PSCs). The petroleum industry faces major challenges, however, in terms of outdated technologies, inherited non-core investments, overstaffing, weak management, and deteriorating infrastructures. These weaknesses reinforce concerns about increasing net oil imports, inefficiencies throughout the system, and the disappointing state of gas development. 4. Important energy reforms have already been initiated by the GOC. They have involved (a) rationalizing of oil and gas pricing to improve the financial situation of the national oil companies, encourage exploration, and increase the share of gas; (b) initiating the separation of government and enterprise functions; (c) the creation in 1982 of the China National Offshore Oil Company (CNOOC) to foster offshore oil and gas exploration; (d) restructuring in 1998 of the two major national companies, China National Petroleum Company (CNPC) and China Oil and Petrochemicals Company (SINOPEC), into two large, new, competing, vertically integrated entities; and (e) making initial public offerings (IPOs) of a proportion of the shares of the national companies, starting with the CNPC in April 2000 and SINOPEC in October, with CNOOC expected to follow in 2001 after a failed listing in 1999. The listing process will encourage efficiencies by clearly separating core from non-core and social activities and ensuring that management concentrate on core businesses and profit maximization. Modernizing China's Oil and Gas Sector: Executive Summary Page iv 5. The GOC, however, recognizes that the existing piecemeal and administered approach to reform, based in part on "mimicking" the market system, has probably reached its limits. The government therefore intends to embark on a comprehensive restructuring to gradually open the sector to market forces and, in parallel, to create a comprehensive modern regulatory framework for oil and gas. THEME II: Major obstacles exist to sector restructuring and regulatory change. 6. Upstream, the geographical division of exploration areas through three major Chinese companies is restricting the competition between Chinese companies operating in the sector. The administration of exploration licenses is deficient in promoting competition. For example, awarding mineral licenses to Chinese companies through bidding process is not applied today in China, and strict terms for extending licenses are not in place. Restrictions on PSC partners' ability to engage in oil and gas trading contribute to reducing the interest of potential entrants. Further improvement of fiscal terms is needed. The decision whether to cooperate with foreign partners rests solely with the Chinese companies. All these problems mean that petroleum resources are not being exposed to the full range of exploration ideas and technologies. 7. Downstream, competition in refining and wholesale operations is limited to CNPC and SINOPEC, retail activities are not fully open to competition, and there are government controls on crude oil and oil products import, export, and pricing. 8. Regulatory obstacles exist, such as the wide diffusion and overlap of responsibilities, and regulation of some important areas is not in place. Some important regulatory functions of SOEs have not been transferred to the relevant government agencies. These obstacles discourage investors, especially foreign ones, are harmful to the consumer and public interest, and jeopardize the GOC's efforts to attract private funds to the sector. 9. The current oil and gas legal framework is deficient: there is no comprehensive oil and gas law; no proper regulatory framework for the sector; authority therefore tends to be provided by regulations rather than by laws; and there are cases of important gaps, as well as overlaps, in government responsibilities for the sector. These deficiencies must be remedied to create the conditions for orderly development, encouraging private investment and protecting the public interest. 10. Overall, these structural, regulatory, and legal obstacles hamper resource development, foster inefficiencies, burden the consumer with additional costs, and frustrate sound development of China's economy. THEME III: A new wave of reforms is needed to improve the governance of the sector, increase competition, and develop modern regulation. 11. Against the background of the transition from a planned economy to a socialist market economy, the GOC aims to create the environment for an efficient petroleum industry to help meet the energy needs of modern China and establish the conditions for Chinese oil and gas companies to develop into world class businesses that can compete successfully as the sector opens. Modernizing China's Oil and Gas Sector: Executive Summary Page v Principles and Objectives for Reform 12. Reform will be guided by principles that include the following: (a) making optimum use of China's petroleum resources; (b) separating government and enterprise functions; (c) bringing competitive pressures to bear on all sector participants to improve efficiency; (d) attracting foreign investment; (e) developing modern regulation; and (f) providing a comprehensive national legal framework for the sector. 13. The objectives of reform are: (a) upstream oil and gas: increased exploration and development (E&D); (b) downstream oil: greater industry efficiency; (c) gas penetration: raising the share of natural gas to 6 percent by 2010; and (d) the creation of a modern regulatory framework consistent with a market-based petroleum industry. Concepts Underlying Structural and Regulatory Change 14. Policy concepts to guide further initiatives include the introduction wherever possible of competitive forces; the light-handed regulation of natural monopolies, such as pipelines and gas distribution systems; and change taking place in a phased progression. 15. The case for market opening is strong. It brings to bear investment, management skills, and technology from all sources; it disciplines the various actors by competition rather than by regulation; and it will make best use of all available resources while also strengthening Chinese companies. This is the model followed for the oil and gas sectors of the leading international economies. 16. With regulatory reform, policymakers will determine the broad policy environment for the sector. Independent regulators will make decisions in specific cases, ultimately concentrating on dealing with dominant market positions and being guided by international standards for technical regulation of health, safety, and environmental protection. The regulatory transition needs to be implemented in a comprehensive, careful, and timely way to achieve the objectives sought by the government. 17. A pragmatic and flexible five-year transition (2001­2005, coincident with the 10th Plan) is proposed for both structural and regulatory change. The proposed transition recognizes the sweeping governmental, administrative, corporate, managerial, and behavioral changes to be faced; takes account of reforms in other areas of the economy, especially the country accession to the World Trade Organization (WTO); and recognizes the long lead times needed to develop and implement the proposed regulatory reforms and the challenges facing the national companies to adjust to the new competitive environment. Modernizing China's Oil and Gas Sector: Executive Summary Page vi THEME IV: Reforming the sector to increase openness and foster competition. 18. Sector reform is designed to achieve the three broad objectives of increased E&D in the upstream, greater downstream efficiency in the oil sector, and accelerated gas penetration. 19. More, but orderly, competition should be gradually introduced to the upstream industry to achieve faster and more efficient resource development. Easing entry would ensure increased involvement of the international oil companies (IOCs) to attract capital and new technologies. Submission of the Chinese companies to competitive pressures and their exposure to and cooperation with international investors would increase their efficiency and improve their competitive ability. The main policy instrument will remain the use of PSCs under competitive fiscal terms. 20. Steps to increase E&D, to be taken in succession, are a review, and if necessary adjustment, of fiscal terms; removal of geographical constraints on the Chinese companies; an increase in exploration areas available for PSC bidding; strict enforcement of and more demanding exploration license terms for the national companies; and independently managed, competitive issuance of new PSCs. 21. Greater IOC presence will be encouraged by improving market access for PSC oil and gas under the control of the IOCs. Thus, in stages, PSC partners should be allowed to market profit gas, then oil, directly; they should be permitted to invest in pipelines; and they should eventually have nondiscriminatory access to all pipelines, regardless of ownership. 22. Crude oil market opening steps are study of the impact of removing crude oil refinery allocations and pricing approvals (with cap prices, if required, during the transition period); eventual discontinuance of refinery gate price approvals; and then the phaseout of import quotas and licenses. 23. Opening of the crude oil market is needed to further unleash competitive forces, but it may result in both greater exports and imports of oil (although net imports will be moderated by greater E&D). Such a development could enhance existing GOC policy concerns about security of the civilian oil supply. This issue has been addressed in the Organisation for Economic Co-operation and Development (OECD) countries by diversifying total energy supply, diversifying oil supply sources, involving competing suppliers, and giving them freedom to obtain oil from any source and to access adequate foreign exchange. 24. A start to greater downstream efficiency in the oil sector was the increased competition resulting from the creation of the CNPC and SINOPEC. The downstream sector, however, has not yet achieved the efficiency gains that must be obtained by the second wave of sector reforms. Additional capital from both Chinese and IOC sources must be mobilized. In addition to capital, IOCs can bring new management skills and improved technology to the sector. Municipal enterprises should be corporatized and pilot projects created to give Chinese companies first-hand experience of fair open market competition, which is stipulated in the WTO accession. By the end of the transition, the Modernizing China's Oil and Gas Sector: Executive Summary Page vii whole downstream should be fully open to capital, technology, and entrepreneurship from all sources. 25. Decisions, to be implemented according to a carefully planned transition, are to study oil and gas taxation, to permit investment by Chinese and joint venture (JV) companies in wholesale products markets, to replace government benchmark pricing with maximum prices for products, to open competition for qualified Chinese companies and IOCs on a pilot project basis in wholesale and retail markets, to accelerate corporatization of municipal enterprises, to remove restrictions on foreign majority participation in retail activities, and finally to open the whole sector to international trade and investment. 26. As to gas penetration, China's gas endowment is underdeveloped and its share of the nation's energy supply is small compared with those of the advanced economies, even to ones dependent on imports of gas. The objective of a 6 percent energy market share by 2010 is a major commitment and can be exceeded in the long term. 27. Achieving this ambitious target, equivalent to expanding the sector by an amount equal to the size of the Italian gas industry, will require increased investment in all segments of the industry and the removal of remaining obstacles to a functioning gas market, including gas quotas and pricing distortions, the CNPC's quasi monopoly on wholesale trading, and inadequate remuneration of transmission services. 28. The gas distribution sector will have an important part to play in achieving the 6 percent target. Attention needs to be given to distribution system planning and to corporatization with a view to improved financing, more aggressive marketing, and addressing the problems of inadequate margins. 29. In conclusion on sector reform, the proposed program would result in strengthened and modernized oil and gas sectors with diversified ownership and operation in an environment where trade flows and prices would predominantly be determined by the market leading to economic efficiency and optimal allocation and use of resources. THEME V: Developing a modern oil and gas regulatory system. 30. There is a broad international consensus that the policy role of government must be distinguished from its regulatory responsibilities and that the enterprises should not be involved in either. The policy role deals with broad issues relating to security of supply; resource management; competitive fiscal terms; definition of market operation; control of pipeline and other natural monopolies; the definition of regulatory principles for health, safety and environmental protection; and dealing with the sector's social issues. 31. The regulatory framework addresses three principal areas: mineral resource management and related fiscal matters; technical regulation for health, safety, and the environment; and economic regulation of natural monopolies. In each area, it may be necessary for regulators to "qualify" or "certify" operators as to their fitness to take part in oil and gas activities, having regard, for instance, to their technical and financial viability. Modernizing China's Oil and Gas Sector: Executive Summary Page viii 32. Regulatory reform is a necessary counterpart of structural modernization and will enable achievement of structural reform objectives. China has the opportunity to make a fresh start in this field and create a modern, efficient, and effective oil and gas regulatory structure. This reform will require the creation of a level regulatory playing field, administered by an independent commission or commissions that will take over environmental, technical, operational, economic regulatory, and permitting functions from a number of different existing agencies. 33. Particular attention should be given to incorporating responsibilities for health, safety, the environment, and technical regulation, including sound petroleum reservoir management, to serve the public interest of China. Project approvals will require the development of environmental assessment and review processes that distinguish appropriately between routine and more complex projects. The regulator in these areas will set technical and environmental standards, regulate the exploitation of subsurface resources to avoid waste, and establish procedures for public consultation and for inspection and compliance. In the area of economic regulation, the regulator will monitor the development of competitive oil and gas markets and deal effectively with natural monopolies. 34. The new regulatory culture will provide transparency in terms of the requirements to be met and the processes for their implementation. This will create an environment of fairness that, together with stability, is another important quality of modern oil and gas regulation. 35. In terms of objectives, by the end of 2005, the GOC should have put in place a fair, stable, comprehensive, and permanent regulatory structure for the oil and gas industry implemented by separate permanent up- and downstream regulatory commissions, to recognize differences in the composition of the sectors and in their regulatory needs and processes. 36. There is a series of implementation tasks to be carried out to achieve these objectives. These tasks include studies of existing regulation; decisions on the transition actions needed; and agreement on programs of further work, such as the development of a regulatory framework for gas development in China. Operational tasks to be dealt with include the modernization of pipeline rate design and the provision of pipeline open access. Implementation of the new regulatory structure involves first the mapping of existing regulation, then the definition of regulatory policies in each of the three main areas of activity, decisions as to related regulatory techniques, and the design and processes of legislative implementation. In parallel with this, the design of the regulatory organizations needs attention in terms of responsibilities, structure, relationships, authority, and resourcing. 37. In conclusion on regulatory reform, completion of these tasks by the end of the transition will equip China with a thoroughly modern regulatory regime responding to high international standards, potentially superior to that of some of the advanced countries. THEME VI: Challenges of the transition and phased implementation. Modernizing China's Oil and Gas Sector: Executive Summary Page ix 38. Numerous tasks have to be undertaken, during a pragmatic and flexible five-year transition, to achieve the objectives of sector reform and the creation of new-style regulation for oil and gas. Their completion will pose major challenges for the GOC. Among the most difficult to overcome will be the need to change mentalities and behaviors. Much stress will be put on the whole system, but the potential gains far outweigh the risks. A flourishing, market-oriented oil and gas sector will improve the oil supply balance; increase gas penetration; reduce atmospheric pollution; bring in new capital, entrepreneurship, and technology; create high-value employment; and serve consumers better in terms of service and pricing. 39. The transition is specially important in terms of the time-consuming creation of the new legislation. A modern legal and regulatory framework for the upstream will attract foreign investment to the development of hydrocarbon resources. Downstream the framework will particularly affect the gas industry, defining the areas for regulation and the responsibilities of the agency responsible for oversight of it. 40. In this connection, an obvious area to start implementation of new-style regulation is the downstream gas industry, from which it could be extended to other areas in subsequent phases. The absence of a regulatory framework for downstream gas hinders this segment's development. Much preparatory work has been undertaken toward remedying this deficiency, and more is planned. The stage is therefore set for a demonstration project in modern regulation for this component of the oil and gas sector. 41. The following abridged five-year "road map" for policy, structure, regulation, and legislation respecting the oil and gas sector summarizes the foregoing proposals. Modernizing China's Oil and Gas Sector: Executive Summary Page x Road Map for Policy, Structure, and Legislation Year Policy Structure Regulation Legislation Oil 2000 Policy statement: Review fiscal, licensing, PSCs. Study development of terms of Legal staff work on Restructure sector. Extention of license Reference (TOR) for research on legal instruments for Modernize regulation. structural and regulatory change. regulation. Study taxation and pricing. Policy directive: Identify responsibility for Prepare inventory and Consolidate regulatory Study impact of removing refinery allocations regulatory implementation. analysis of petroleum processes. and prices. legislation and regulation. Create regulatory "road map" of Study phaseout of import quotas and licensing. existing processes. Gas Create interim regulatory Study phaseout of in- and out-Plan pricing. organization. Oil and Gas Study monitoring and reporting Study pipeline open access and rate making. on regulation and market development. Oil 2001 Policy decisions: Chinese companies utilize their right to explore. Regulatory decisions on pipeline Assess use of existing legal Remove crude oil rates and access to support oil instruments and needed allocations and import Introduce imports quotas for nonstate companies. and gas marketing by PSC changes. restrictions. partners (effective 2002­03). Set up a scheme to remove import quotas and Assess need for legislative Phase out and unify in- licensing. Remove regulatory and policy changes; initiate if and out-Plan prices for functions from state-owned necessary. gas. Allow Chinese and JV companies to invest and enterprises (SOEs) and return operate in wholesale oil products markets. policy function to the GOC. Legal staff tracks Policy directive: legislative implications. Targets for PSC blocks to Introduce maximum retail prices for gasoline and Initiate monitoring and reporting be licensed. diesel. on structure and regulatory Legal staff tracks legal changes and market behavior. drafting needed. Gas Phase out in-Plan gas allocations to extent Begin study and decision possible. making on regulatory policy (complete early 2002). Extend market-oriented prices to all new gas projects. Begin study and decision making on regulatory techniques Chinese and PSC companies to sell gas directly (complete late 2002). to consumers. Encourage negotiated gas prices for new projects. Promote market planning and development. Oil and Gas Increase exploration blocks available for licensing for PSCs. Enforce terms for extension of exploration licenses and increase the cost of holding them. Make new and existing blocks eligible for PSCs. Modernizing China's Oil and Gas Sector: Executive Summary Page xi Road Map for Policy, Structure and Legislation, (continued) Year Policy Structure Regulation Legislation 2002 No new policy statements Oil Complete study and decision Legal staff to track legal or decisions required. Remaining approval of crude oil making on regulatory policy. drafting needed; initiates refinery gate prices eliminated. work as policy and technical Policy level receives Complete study and decision work is approved. briefing on progress in Chinese and PSC companies sell making on regulatory techniques. sector structure and profit oil directly. Completion of technical regulatory reform. Interim regulatory organization regulations proceeds while Pilot projects for liberalization of continues oversight of transition to Petroleum Law is drafted. products begin. competitive products markets, progress of other structural and Oil and Gas regulatory change Allow foreign investors to own a majority interest in pipelines. Introduce a regulated open-access pipeline regime. 2003 Issuance of revised and Oil No new initiatives Regulations freeing up oil and final policies on oil and Remove restrictions on foreign gas commodity markets. gas pricing. majority participation in retail Interim regulatory organization has gasoline and diesel. and allow foreign achieved high degree of Legal staff completes work companies to own majority interest in cooperation and coordination. on regulations. refineries. Interim regulation system is functioning effectively in supporting structural changes. 2004 Policy decision, following Interim regulatory organization Completion of all regulatory formal review, as to completes formal review. drafting. whether to complete regulatory reform. Responsibility center reviewed by Positive State Council State Council. decision authorizes any necessary work on laws. 2005 No further policy decisions Oil Concentrate all regulatory Legal drafting is continued required. Removal of crude oil import quotas functions and activity under interim and completed. and licensing. regulatory organization. National People's New legal structure is enacted Congress approval; new Reduce product import tariffs. Period of intensive staff training by the National People's law-making required. and cooperation. Congress and other Eliminate import-export quotas and lawmaking authorities, as product licensing system. Up- and downstream regulatory appropriate. commissions appointed and Eliminate all economic controls on organized; absorb functions of investment in all sectors. interim regulatory organization. Accelerate corporatization of municipal enterprises in the wholesale market, and integrate with a program of share listings. Remove import quotes and licensing. Introduce bidding for new exploration blocks by Chinese companies. Modernizing China's Oil and Gas Sector: Chapter 1 Page 1 CHAPTER 1: A SECTOR IN TRANSITION: CHINA'S OILAND GAS SECTOR MOVINGTOAMARKET ECONOMY 1.1 Background China's energy sector has become the second largest in the world. In 1999 the country's primary commercial energy production and consumption amounted to 1100 and to 1,220 mtce, respectively. Despite a slower growth during the last decade, coal remains the dominant source of energy, accounting for about 67.1 percent in 1999 compared with 76.2 percent in 1990 (see Table 1.1 and Figure 1.1).1 Oil production grew 2.2 percent per annum during 1990­97, but stagnated at around 230 mtce (154 mtoe) in 1998 and 1999. Primary energy consumption of oil increased at the higher annual rate of 8 percent during the same period, reaching 286 mtce (192 mtoe). The country became a net oil importer in 1993. Net imports of crude oil and products increased to about 43.81 million ton in 1999, about 22% of the primary oil consumption Gas production and consumption increased at a modest pace of 5.7 percent in the 1990s to about 35.9 mtce (25.2 Bcm). The share of gas in the commercial primary energy consumption increased only slightly during 1990­99 from approximately 2.1 to 2.8 percent, despite the government's stated objectives, since the early 1990s, to increase gas penetration. China's reserves-to-production ratios (R/P) for oil and gas highlight the weaknesses of the sector. A low R/P of about 14 for oil potentially indicates insufficient investment in E&D (primarily an upstream issue), whereas the high R/P of about 40 for gas points to a low rate of resource mobilization and stagnation of gas market penetration (primarily a downstream issue). To be more specific on the oil side of the issue, rising imports are indicative of the industry's failure to boost production in step with rising domestic requirements because of a lack of innovative exploration ideas, outdated technology to increase recovery ratios in producing fields, and shortage of investment funds to bring new fields into production. 1Source: China Statistical Yearbook 1991­2000. Modernizing China's Oil and Gas Sector: Chapter 1 Page 2 Table 1.1 Primary Energy Production and Consumption, 1990-1999 (mtce) Coal remains dominant despite a steady decline of its share from 1990 to 1999 . . . Production Consumption Energy Sources 1990 % 1999 % 1990 % 1999 % Coal 771.1 74.2 750.2 68.2 752.1 76.2 818.6 67.1 Oil 197.4 19.0 229.9 20.9 163.8 16.6 285.5 23.4 Natural Gas 20.8 2.0 34.1 3.1 20.4 2.1 34.2 2.8 Hydropower 49.9 4.8 85.5 7.8 50.3 5.1 81.7 6.7 TOTAL 1039.2 100.0 1100.0 100.0 987.0 100.0 1220.0 100.0 Figure 1.1 Changing Structure of Primary Energy Consumption . . . oil share slightly increased from 1990-1999 and gas share stagnated . . . Hydropower Hydro power 7% Natural Gas 5% Natural Gas 2% 3% Oil 17% Oil 23% Coal Coal 76% 67% 1990 Oil and Gas Consumption 1999 Oil and Gas Consumption Figure 1.2 Growing Oil Import Supply Gap . . .and oil imports increased significantly. Mill. ton 250 200 Net Oil Imports 150 OilPProduction Oil roductiom 100 Oil Consumption Oil C onsumptiom 50 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Modernizing China's Oil and Gas Sector: Chapter 1 Page 3 1.1.1 Sector Change and Legal Framework The organization of the oil and gas sector in China has been in a state of continuous change, especially during the last two decades. From 1949 to 1955, the oil and gas sector was under the control of the Bureau of the Petroleum Industry in the Ministry of Fuel. In 1955 the bureau was elevated to the Ministry of Petroleum Industry (MOPI), which oversaw all aspects of hydrocarbon exploration, development, and transportation. In 1970 MOPI was merged with the Ministry of Coal and Ministry of Chemical Industry; these ministries were split again in 1975. In 1988 MOPI was dissolved. Simultaneously the CNPC was created to exercise MOPI's former operational roles. It also acquired some of that ministry's policy functions. A new Ministry of Energy (MOE) took over MOPI's former administrative responsibilities, as well as those policy functions that had not gone to the CNPC. In 1994 the MOE in turn was eliminated. Most of its functions were acquired by the State Development Planning Commission (SDPC), but some of the policy responsibilities went to the CNPC which, partly because of its strength in personnel resources, continues to exercise a policy role. Until 1998 the CNPC was in charge of almost all the onshore petroleum exploration and development activities in China, including negotiations and administration of agreements with international oil companies through its subsidiary, the China Oil and Natural Gas Exploration and Development Corporation. The China National Offshore Oil Corporation (CNOOC), created in 1981, was responsible for virtually all the offshore petroleum operations. The Ministry of Geology was in charge of geological work. The Petrochemical Corporation of China (SINOPEC), established in 1983, was responsible for most petroleum refining and petrochemical production based on liquid petroleum feedstocks. The Ministry of Chemical Industry (MCI) is responsible for most petrochemical plants using natural gas and coal as feedstocks. The China Chemical Industry Import/Export Corporation (SINOCHEM) is in charge of oil and products trading. Starting in 1998, the government initiated another major change in the sector structure and corporate governance of the state companies operating in the sector through (a) restructuring the state oil and gas assets to transform the CNPC and SINOPEC into two vertically integrated companies; (b) separating the core business of the CNPC and SINOPEC from non-core businesses and social services and transferring the core services to newly incorporated entities, PetroChina Company Ltd. and China Petroleum &Chemical Corporation Ltd. and finally, (c) making initial public offerings (IPOs) for PetroChina Ltd.and SINOPEC). These IPOs are based on a government decision to allow minority foreign shareholding in the major state-owned entities operating in the sector. The process started slowly. The successful IPO of 10 percent of the shares of PetroChina, Ltd. and SINOPEC Ltd. indicate the strong but cautious interest of international oil companies (IOCs) and financial markets in China's oil and gas sector. Preparation for an IOP of CNOOC Ltd. is ongoing. Modernizing China's Oil and Gas Sector: Chapter 1 Page 4 Finally, significant steps have been taken to gradually bring oil and gas prices up to market levels. Domestic crude oil and products are now linked to international prices, and gas prices have been increased to levels close to and, sometimes, above long-run marginal costs. However, the necessary linkage to gas competitiveness with other fuels was not ensured. The GOC's approach to sector change and reform outlined above can be characterized as a piecemeal one. The problems stemming from this approach, and from the legal and regulatory deficiencies identified in the balance of this section, are further discussed in section 1.2. The current oil and gas legal framework in China is deficient. Thus, (a) There is no comprehensive oil and gas law. (b) Similarly, there is no comprehensive regulatory framework for the sector. (c) For the most part, authority is provided by regulations rather than by laws. (d) There are, in some important cases, gaps and, in other cases, overlaps in the coverage of these regulations. The overall effect is that the existing regulatory framework is fragmented, responsibility is dispersed between different centers, and there are clear overlaps in responsibilities. For the long-term successful development of the sector, an oil and gas law for both upstream and downstream will be required. Many countries have found that the orderly development of the oil and gas sector is facilitated by a sector-specific law whose purpose is to create the conditions necessary for private investment while safeguarding the public interest. (A relevant example is China's Electricity Law.) However, new laws take a long time to develop, and their content is difficult to foresee, particularly in the case when a new natural gas sector is developing rapidly. Given the fast track the government has taken in the sector, such laws will need to be developed in tandem with the implementation of regulations and development of the sector. 1.2 Barriers to a Successful Transition Despite the progress achieved during the last two decades, major problems are still impeding the development of the sector and its efficient operation. This report focuses on two prerequisites to a successful transition to further market orientation and increased efficiency in the sector: the creation of a competitive business environment and the introduction of modern regulation. From the standpoint of that focus, key challenges and problems include the following: Challenges (a) Oil production growth has been outpaced by domestic demand growth. This has resulted in rising imports since 1992, despite China's favorable petroleum resource potential. Domestic oil demand is expected to continue to grow significantly. Each Modernizing China's Oil and Gas Sector: Chapter 1 Page 5 percentage point growth in petroleum demand would require a supply increase of about 2 million tons in the year 2000 and of about 5 million in the year 2010. (b) Gas consumption has not increased its share of final energy consumption. Gas penetration has increased from only 2 percent in 1990 to 2.8 percent in 1999, despite the declared government policy to increase gas penetration in the energy balance to 6 percent by 2010. Even if primary energy consumption increased by only 2 percent annually in the coming decade (compared with 4 percent recently), achieving the government's target of 6 percent gas penetration by 2010 would require an additional 60 Bcm of gas to be consumed. This is equivalent to adding the whole Italian gas industry in one decade. Development of a market of this size in China would require the completion of five gas projects of the capacity of the planned West­East pipeline. Key Problems That Present Barriers (c) Government roles of policymaking and regulation are still not clearly separated from its ownership and governance roles. Specifically, policy and regulatory functions are widely diffused and interwoven. The "command and control" approach to regulation is still pervasive. And within the existing system, there is insufficient attention to human health, safety, and environmental protection. (d) The state-owned enterprises (SOEs) retain policy and regulatory functions. SOEs, listed (or about to be listed) on the stock exchange, are still exercising functions that can lead to conflict-of-interest situations and discriminatory practices against possible competitors. (e) Governance of the SOEs is not being appropriately implemented. Seventeen years after the enactment of the Company Law and several corporate restructurings, governance of most, if not all, state-owned companies is still not properly exercised through their boards of directors and articles of association (charters). Interference in management decisions by government agencies and holding (mother) companies has continued after incorporation of the business entities and, in some cases, even after their listing in national and international stock markets, which has reduced management autonomy and weakened accountability. (f) The sector is inefficient. Inefficiencies are a result of (i) relatively outdated technologies, partly because of insufficient innovation; (ii) corporate structures that have inherited non-core investments ("side businesses") rather than aggressive investment in innovation and core exploration and production businesses; (iii) overstaffing stemming from the SOEs' perceived social obligations and overstaffing in the core petroleum business; (iv) the weakness of management processes and corporate governance; and (v) underutilization and deterioration of the existing infrastructure because of unsafe operational procedures and inadequate maintenance. (g) Allocation of some gas volumes and structured gas prices are among the most important impediments to the optimal use of gas resources. More importantly, they act as disincentives to the mobilization of financial resources required for sector development. Modernizing China's Oil and Gas Sector: Chapter 1 Page 6 Problems of the Piecemeal Approach The persistence of these problems and the partial achievement (and in some cases the failure to achieve) the government `s stated objectives for the sector stem mainly from the piecemeal approach to reform. Examples include the following: (a) Restructuring, corporatization, and commercialization of SOEs has taken place without the necessary parallel development of a competitive framework and of independent regulation. This has created major conflicts of interest. For example, profit-oriented operators are still entrusted the responsibility of designing and enforcing operating and safety standards; new entrants to the sector have to associate with state-owned companies that have dominant market positions and that exercise regulatory powers. Additionally, there are market power situations that discouraged new entrants and tend to discourage foreign investments in the sector. (b) Conflict-of-interest situations are becoming more apparent after the decision to link the three major companies to international equity markets. (c) Increased gas prices, without phasing out the gas allocation system and improving the pricing structure to reflect supply costs have failed to provide adequate incentives to increase and rationalize the gas supply and consumption. (d) Regulation remains deficient, with responsibilities dispersed and overlapping, a lack of effective regulation in some important areas, the retention of regulatory responsibilities by SOEs, and the continued absence of a unified legal system that provides adequate transparency. If not addressed, these problems could jeopardize the future development of the sector and, more importantly, limit the ability of the Chinese operators to compete in the more open environment defined by the terms agreed to by the government for China's accession to the World Trade Organization (WTO). 1.3 Policy Objectives This report seeks to address these challenges and problems, provide reform concepts and to achieve the broad policy objectives established by the government for reform of the sector, which are as follows: 1. Make optimal use of China's petroleum resources. Given the extent of the country's petroleum resources, increased E&D could create the capacity to reduce the rapid rise in China's net oil imports and temper any concerns the GOC may have about foreign exchange costs and the security of imported oil supply. Greater E&D would as well contribute to increase gas supply and diversify the country's energy mix. Modernizing China's Oil and Gas Sector: Chapter 1 Page 7 2. Remove the regulatory functions from the SOEs and create a clear, modern regulatory framework. This will be obtained through two fundamental actions: (a) Removing all policy and regulatory functions from the operations of the SOEs. This will enable them to focus further on the profitability of business operations, thus reducing overstaffing and high operating costs. (b) Creating a new legal system to provide a proper basis in law for comprehensive oil and gas regulation. 3. Bring competitive pressures to bear on the SOEs and other sector participants to improve efficiency. Competitive forces, rather than government control and direction, are the proven means to make best use of all available resources. The management of SOEs will be improved and their capital better employed, and they will be transformed into the world-class companies that they need to be to survive and prosper in the long term. 4. Attract foreign investment. The GOC's aim is to leverage the technical and financial resources of skilled foreign companies to invest in both the upstream and downstream oil and gas sector. Such investment can be attracted through their expanded participation in PSCs, through investments in pipelines and other infrastructure, and by continued IPOs of shares in the main SOEs. 5. Increase gas penetration. The GOC has a publicly stated objective to increase the share of natural gas in the energy balance from the present 2 percent to 6 percent by 2010. Increased gas penetration will reduce coal's dominance, thereby mitigating the adverse environmental impacts of coal use, especially on health (reduction of particulate emissions) and agriculture (reduce acid rain). 1.4 Key Areas for Comprehensive Reforms Comprehensive sector reform is a critical element necessary to meet the government's policy objectives set out in section 1.3. The piecemeal approach is not working, and the policy objectives are in danger of not being met. International experience in developed and developing countries shows that increased reliance on market forces, combined with proper government oversight of the sector, leads to increased economic efficiency and attracts the investment and entrepreneurship needed to develop oil and gas resources to meet the country's needs. The reforms must be integrated and focused on the following: (a) Sector structure--meaning conditions under which qualified enterprises can enter and make investments in all segments of the oil and gas sector and subsequently carry out activities, such as producing, selling, buying, importing, and exporting. (b) New style regulation--meaning government control and direction of business enterprise activities that are not subject to adequate disciplining by competitive forces. The activities in question are typically health, safety, and environmental protection, sound petroleum reservoir management and regulation of natural Modernizing China's Oil and Gas Sector: Chapter 1 Page 8 monopolies, such as pipelines and gas distribution systems, particularly in terms of prices and rights of access to services. The oil and gas sectors of most leading industrial economies are based on the principle of open, functioning markets. The beneficial effects of market opening on petroleum development have been demonstrated in recent years in such countries as Argentina, Bolivia, and Canada. International organizations like the EU, the International Energy Agency, and the Organization of Latin American Energy (OLADE) all endorse open market oil and gas policies. In countries where oil and gas sectors are closed or highly controlled, industry efficiency is low and supply costs are high, leading to excessive consumer prices and an unnecessary drain on the government budget; SOEs' commercial objectives may be subordinated to government policy considerations; labor forces are bloated; environmental management is often substandard; technology is outmoded; "best practices" in engineering design and operations are not consistently instituted; some resource development opportunities, particularly for gas, may be neglected; petroleum reservoir practices are usually less than optimal; domestic oil products specifications fall short of international norms; and the quality of retail service is inferior. In all reforming countries, as former public enterprises become subject to market competition and have to demonstrate profitability, pressures increase on their management to cut costs in such areas as environmental protection and to take advantage of any remaining dominant market positions that they may have. This tendency is developing in China. It must be offset by vigilant, independent regulation to protect the public interest. A broad international consensus is developing as to the appropriate functions of governments in relation to the oil and gas sector when market principles are implemented. Regulatory responsibilities should not be exercised by SOEs, and regulation should be properly separated from the government's policymaking functions. This will increase the public's confidence, create a "level playing field" for enterprises of all kinds, and help improve the investment climate. 1.5 Guidelines for Reform and Phased Implementation Two basic principles are proposed to guide the process of further reform, and they are applied in Chapters 2 and 3: (a) Sector structure: Progressively greater reliance must to placed on market forces and the gradual opening of the sector to trade and investment to achieve optimal use of human and material resources and greater productivity. Market opening and reliance on competitive forces will (a) allow and invite investment, enterprise, and technology from all sources, domestic and foreign, to take part in the development of all phases of the oil and gas industry; and (b) put pressure on all participants, newcomers as well as incumbents, to invest and operate efficiently and minimize costs to the benefits of consumers, thereby Modernizing China's Oil and Gas Sector: Chapter 1 Page 9 reducing the need for administrative interference. Chinese companies will benefit from being exposed to international competition through a gradual market opening. Both theory and practice show that functioning markets are the best means of fostering investment, making most efficient and rational use of resources, strengthening successful corporations, and at the same time safeguarding consumer interests. (b) Regulation: The aim must be to create a modern framework in which economic regulation protects the government and consumers from the misuse of monopoly powers and technical regulation is carried out to high international standards. The transition from a planned economy to a socialist market economy does not mean the end of government intervention. Rather it means a shift from all-pervasive intervention to more selective and focused intervention to serve the public interest and provide an environment for fair market competition. New-style regulation requires first the separation within government of the function of regulation from the function of policymaking and the creation of new regulatory institutions. Second, it involves a change in emphasis of regulation. Thus, as functioning markets develop for oil and gas, market-intervention regulation will diminish and eventually disappear. Where markets do not work because of the presence of natural monopolies like pipelines and gas distribution systems, new-style economic regulation will be put in place to prevent the abuse of dominant positions and encourage the functioning of markets for the commodities that flow over those pipelines. In the area of technical regulation, high and uniform international standards will be applied by the new regulatory institutions. In all respects, the public interest will therefore be safeguarded by competition in some markets; by the regulation of monopoly where markets do not work; and by the protection of health, safety, and the environment where competitive pressures do not necessarily work to secure sound practices. A flexible and pragmatic transition is required that recognizes the extent of the needed changes and, in many cases, their link to the macroeconomic situation; the initial adaptation difficulties that will be faced; the importance of maintaining the pressure for change; and at the same time, the wisdom of adopting a phased approach that includes a program of further studies and embodies decision points as progress is made toward the final goals. Reforms must be synchronized with China's international commitments, but not limited by them. A five-year transition period is proposed (2001­05), coincident with the 10th Plan. Modernizing China's Oil and Gas Sector: Chapter 2 Page 10 CHAPTER 2: CREATINGA COMPETITIVE SECTOR STRUCTURE 2.1 Overview and Objectives China has taken the first steps toward restructuring its oil and gas industry. The restructuring of the CNPC and SINOPEC and IPOs for PetroChina Ltd. and SINOPEC Ltd. and others are examples of moving toward a more market-oriented approach. Some progress has therefore been achieved, but it has been slow relative to certain other sectors, such as telecommunications. Much therefore remains to be done, and the pace of reform should be speeded up. Key issues that oil and gas sector reform must deal with include the following: (a) insufficient levels of E&D exploration; (b) production and supply inefficiencies; (c) lack of competition, particularly in onshore exploration and in the downstream sector, both gas and oil; (d) traditional sector regulation that limits competition; and (e) inadequate market development and penetration of natural gas. To adequately address these issues and reach the GOC's related policy objectives identified in section 1.3, structural changes based on market principles are recommended that will progressively increase competition and achieve the following objectives: (a) increased upstream exploration and development; (b) greater efficiency in the downstream oil sector; and (c) increased gas market development and penetration. First, to move in the direction of a market economy and to create functioning markets in the upstream sector, a prerequisite is to foster competition by increasing the number of oil and gas suppliers. At the moment, for example, crude oil can only be put on the Chinese market by the Chinese companies presently producing alone or in conjunction with their foreign PSC partners and by the Chinese companies allowed to import under licenses. This is not a sound basis for a competitive crude oil market. Second, to increase investments in E&D from existing and new companies, greater infusion of foreign capital, technology and expertise should be sought and broader access Modernizing China's Oil and Gas Sector: Chapter 2 Page 11 to petroleum mineral rights provided. At the same time, the upstream fiscal system should be reviewed to verify that it remains internationally competitive for all current and prospective players. Third, all SOEs and other companies need access to markets to sell their products, whether they are crude oil, oil products, or natural gas. Over time, the remaining government controls on prices and volumes will therefore have to be phased out. 2.2 Corporate Governance and Ownership The current role of China's dominant oil and gas companies will change with the transition to a competitive market. Areas that could be affected include ownership structures as a result of public listings; new management, which may be brought in to deal with the challenges of competition; and implementation of future policy, which will have its effects. With the advent of an open market, competition, and greater participation by foreign investors, pressure will be increased on existing players in the oil and gas business to improve their operating performance. The pressure will lead to greater accountability that will help foster change. Corporate decision making styles are likely to move toward decentralized and performance-based decision making. Corporate governance properly carried out by independent boards of directors should reduce the degree of government influence on and interference with day-to-day operations. Government agencies should focus on setting policies, ensuring the operation of a fair competitive market, and managing the government's assets in the sector through boards of directors. Difficult behavioral changes will have to take place on the part of the government and the enterprises, but without them, progress toward functioning markets will be impeded, and associated efficiency gains will be forgone. 2.3 Increased Upstream Exploration and Development By increasing upstream competition, there will be more rapid and efficient petroleum resource development. A first step would be to increase the activity levels in the sector by better harnessing the capital, technology, and entrepreneurship of the IOCs. At the same time, the Chinese companies could be made stronger both by the action of competitive forces and by productive relationships with IOCs. Three areas need to be addressed to achieve this: better access by qualified companies to petroleum mineral rights, access to markets, and pricing and allocation reform. 2.3.1 Access to Petroleum Mineral Rights Minerals licensing policy, including the conditions for licensees to enter into PSCs, along with E&D fiscal terms, is the most effective policy instrument to promote increased exploration activity by the IOCs. Today SOEs apply to the Ministry of Land and Resources for E&D licenses and receive them on a "first come, first served" basis, unless the acreage is reserved for other purposes. The SOE then decides whether to explore on its own or to cooperate with an IOC under a PSC. IOCs are only allowed to Modernizing China's Oil and Gas Sector: Chapter 2 Page 12 participate in exploration and production under PSCs. Only 5 percent of onshore acreage, but most of the offshore, is under PSCs. At present, it is too easy for incumbents to obtain license extensions, and the cost of holding large blocks of exploration rights is low. The disadvantages of current mineral rights licensing system include: market competition mechanism is not introduced into the process of obtaining licenses, and the current practice of extending licenses does not give the licensees an incentive to explore effectively. Reform in this area is thus necessary. Strict enforcement of exploration license terms is required, together with an increase in the costs of holding the licenses. The intent of this step is to improve the relinquishment process to ensure that licensed areas that are not ranked highly by one company are made available to others that may see the prospects differently. The result should be an accelerated and more efficient development of petroleum resources. As the first step toward increasing competition within the sector in an orderly manner, Chinese E&D companies must utilize their rights to explore throughout the country. Exploration blocks should be obtained through bidding processes. A more aggressive petroleum mineral rights licensing policy should be implemented concurrent with greater and more orderly competition among Chinese companies. This policy should allow the Chinese companies to compete in the upstream industry without any geographical limitation; maximize the amount of mineral rights available for exploration; accelerate the turnover of already-licensed mineral rights; and, to the extent possible, encourage an increase in the proportion of all rights available for PSCs. Second, foreign capital, technology and expertise should be leveraged. This is a proven approach used effectively to open markets that previously had "closed" oil and gas economies. Worldwide experience over many decades has demonstrated that the best way to find and develop oil and gas reserves is to allow a wide range of exploration ideas and engineering expertise to be applied to the basic raw material, namely, mineral rights in petroleum prospective areas. The IOCs are valuable vehicles for such ideas and engineering practices. When they are allowed access to petroleum jurisdictions where SOEs were previously dominant, they can often by their own activities bring about dramatic changes in the rate and efficiency of oil and gas development. At the same time, their presence can act as a valuable stimulus to the incumbents, both by the action of competition and also by the "demonstration effects" that the IOCs may foster. Third, the percentage of exploration and production blocks for PSCs should be increased when possible. PSCs should be promoted by increasing the relinquishment of acreage underutilized by SOEs and should be awarded competitively. PSCs have worked well in China and are well understood by the government and by the IOCs. This model can be used in the future, but a competitive bidding procedure should be introduced. Until a bidding procedure is developed for all companies, Chinese companies can continue to receive new exploration blocks according to the current procedures. Under a competitive bidding process for PSCs, after a block is awarded to a Chinese company, the agency responsible for administering petroleum mineral rights would call for bids Modernizing China's Oil and Gas Sector: Chapter 2 Page 13 from all interested parties for a PSC on that block. The basis for selection of the PSC partner would be the highest bid in a combination of work commitments and profit sharing. The successful PSC bidder would then carry out its work commitment, exploring for and, if successful, developing hydrocarbons on the block. The purposes of this step are first, to manage the awarding of PSCs independently of the SOEs; second, to increase the number of PSCs; and third, to bring other qualified Chinese companies, as well as IOCs, into the exploration effort. The principal constraint to effective use of this policy instrument today is that most prospective petroleum areas are under license, and significant new areas are not expected to be added to the exploration pool through the relinquishment process during the next several years. Last, to encourage IOC investment, fiscal terms should be competitive and periodically reviewed to ensure that the underlying fiscal systems for all players remains internationally competitive and that they are consistently applied to all enterprises. If deficiencies are revealed, for example in regard to overall competitiveness or in relation to natural gas development, they should be corrected (refer to Annex 2). The recommendations are summarized in Boxes 2.1­2.5 and in Table 4.1. Box 2.1: Sector Reform Actions: Access to Petroleum Mineral Rights The following actions are proposed to improve access to mineral rights and increase exploration: · Review fiscal terms to assess their international competitiveness and effectiveness to achieve the objective of greater E&D (to be carried out immediately). · Initially ensure that the three Chinese E&D companies utilize their right to explore anywhere in China, including onshore or offshore (from 2001). · Increase the number of exploration areas available for the bidding and award of PSCs, and offer more prospective exploration rights (from 2001). · Strictly enforce the terms for extension of exploration licenses, and increase the cost of holding licenses (from 2002 or as soon as possible). · Make all new and relinquished exploration blocks eligible for PSCs through annual competitive rounds (starting in 2001) managed by an independent agency that has the authority to sign the PSC. · Ultimately consider introducing the practice of allocating new exploration blocks among the Chinese companies by some form of bidding. 2.3.2 Access to Markets A greater upstream presence by IOCs will help to attain the objective of increased E&D activities. However, IOCs will be more ready to enter into PSCs if they have access to markets. This is of particular importance in gas-prone areas because the commercialization of gas requires strong marketing efforts. The companies would be helped in this direction if they can market their share of oil and gas production directly, and if they can be sure of having access to the needed pipeline capacity, either by using Modernizing China's Oil and Gas Sector: Chapter 2 Page 14 others' transmission pipelines or building their own. Presently PSC gas can only be marketed by the SOE or by the SOE in conjunction with the PSC partners. This presents a serious disincentive to gas exploration and development by IOCs. Arrangements that allow all partners to decide independently how they market jointly produced gas are the international norm. Each partner can then maximize the value of its share of production. If this were possible in China, there would be greater IOC interest in PSCs, particularly in gas-prone areas, and more vigorous and successful subsequent marketing efforts. In regard to gas, the IOCs have very broad and varied experience worldwide in development and marketing by investing in pipelines, by innovative arrangements with consumers and, in some cases, by building and owning gas-fired electricity generation. This is known as the creation of a natural gas "value chain." Conversely, the IOCs are not interested in leaving their gas marketing, and the associated revenue stream, in the hands of other parties. If the conditions are created for the IOCs to market their profit gas directly, they will approach gas exploration more confidently, and their efforts, if successful, could entrain important further benefits for China's energy economy by way of more rapid gas market development and associated investment. Foreign PSC partners should be allowed to invest and have majority interests in pipelines to increase the attraction of PSC arrangements to the IOCs, especially in regard to PSCs in gas-prone areas. However, producer-owned pipelines will require special attention. They will of course be subject to regulation to ensure that access to their services is equally open to all parties, that their rates are reasonable, and that there is no abuse of monopoly powers by their owner(s). For regulatory and taxation reasons, pipelines that are owned by other corporations, including by petroleum producers, should be constituted as independent legal entities with separate management and accounting (or, as a minimum, be constituted as separate profit centers of the producing companies). This step has in a sense been anticipated in the July 12, 2000, announcement of the West­East Gas Pipeline Project that opened the possibility of foreign investment in the project. Where pipelines already exist, all producers, including PSC partners, who have rights to market oil and gas directly, must have access to each other's pipelines. This was historically a significant problem in the development of the North American oil and gas market. It was overcome by regulatory measures to enforce open pipeline access for all potential shippers. This had a profound effect on the development particularly of efficient, expanding markets for natural gas. Allowing all producers, including foreign PSC partners, access on a nondiscriminatory basis to oil and gas pipelines regardless of the ownership of those lines will release the same potential in China. Open access pipelines must transport a fully fungible gas commodity. They therefore have to state and enforce stringent rules for the quality of gas to be accepted into their systems. Both the pipeline and its shippers are therefore vigilant about the quality issue. In an open access regime, this kind of policing would deal with the current problem.2 2 Open access will therefore provide a solution to the present regional problem of producers introducing off-specification gas to the transmission pipelines. Modernizing China's Oil and Gas Sector: Chapter 2 Page 15 In regard to crude oil, the same issues apply, but perhaps to a lesser degree. This is because at the present stage of China's petroleum development, crude oil markets are more homogeneous and transparent than gas markets, and some transportation infrastructure is in place (pipelines and rail). The case for IOCs being allowed to sell their crude oil directly relates more to the beneficial effects that should follow in terms of bringing supplies from more sources and greater competition in the refinery crude oil market than the incentive for IOCs to engage more vigorously in upstream operations. Allowing foreign PSC partners to market oil on an equal footing with the three Chinese E&D companies would have positive effects in two areas. First, it would help establish a competitive upstream market with consequent efficiencies stemming from economically optimal crude oil allocation. Second, it would encourage IOCs' E&D activities by ensuring that they will be able to compete for domestic crude oil markets on a level playing field with the SOEs. Box 2.2: Sector Reform Actions: Access to Markets The following actions are proposed to improve the access of oil and gas producers to markets: · Allow foreign PSC partners to market profit gas directly, at prices established through buyer-seller negotiations (2001). · Allow foreign PSC partners to market profit oil on an equal footing with the three Chinese E&D companies (2002). · Allow foreign PSC partners to invest and have majority interests in pipelines (2002). · Grant foreign PSC partners access on a nondiscriminatory basis to oil and gas pipelines regardless of the ownership of those lines (2002). 2.3.3 Introduction of Market Forces: Crude Oil Pricing, Allocation, and Competition Although crude oil and products pricing mechanism has been reformed and prices are now related to international market levels, regulations and accepted practices still constrain commercial activities of oil market players at present. This control system prevents the SOEs from acting in completely commercial ways. To achieve a fully functioning market for crude oil and to gain the benefits of the competitive forces that it will unleash therefore requires further reform of the pricing mechanism, phasing out of the import licensing system, and of any other government interventions in the crude oil market that adversely affect the companies' commercial decisions. Refinery gate prices of crude oils are determined under indicative inter-company agreements on crude oil supply, coordinated by the government, and linked to world levels. In the event that the companies cannot reach agreement, coordination of these pricing arrangements would be provided by the SDPC, which is also responsible for indicative regulation of retail gasoline and diesel prices. Although allocations of crude oil volumes between the companies are not enforced, regulations give government agencies Modernizing China's Oil and Gas Sector: Chapter 2 Page 16 the right to do so. These actual or potential measures present regulatory obstacles in the transition to a fully functioning market. They will therefore have to be phased out to achieve market efficiencies. A phaseout of the crude oil import licensing system would create an environment that would help suppliers and buyers to negotiate market prices for domestic crude oil. The result would be a fully rational utilization of oil supplies. During the phase out of crude oil pricing controls, three issues need to be addressed: the units of measurement (volume or weight?), the premiums or discounts to be applied, and the provisions for quality adjustments reflecting such matters as density and sulfur content. A phase out, required under China's WTO agreements, would progressively enlarge the refiners' supply options. Pressures would be created to negotiate prices for domestic crude oils that would fully reflect international prices for similar qualities. Such pricing would be in the interest of both sellers and buyers: both sets of actors would be able to take their own optimizing decisions. In the case of buyers, this would extend to the refinery level. This has become an almost universal practice in the refining industries of the industrial countries. However, it will take time for China's refining sector to make the investments needed to take advantage of the new feedstock sourcing flexibility, as well as to become competitive against imported products. A study should precede the introduction. Security of Oil Supply China has become a significant net oil importer and is likely to remain so, although import growth could be moderated by greater and more successful E&D. Moreover, if controls on oil exports, imports, and prices are removed, both exports and imports may increase. This could enhance any existing policy concerns on the part of the GOC about the security of oil supply for civilian needs. Such concerns will have to be understood better before specific prescriptions can be put forward. However, as an aid to perspective on the GOC's concerns and possible means to deal with them, some observations are provided in Annex 3. Box 2.3: Sector Reform Actions: Pricing, Allocation, and Competition The following actions are proposed to phase out government price-setting and quotas: · To achieve market efficiency, the SDPC will not retain the right to interfere with prices agreed between companies or otherwise intervene in inter-company matters respecting crude oil prices; · Import quotas and licensing systems for crude oil will be phased out on a predetermined schedule (starting in 2001 and finishing in 2005). 2.4 Increased Downstream Oil Efficiency Modernizing China's Oil and Gas Sector: Chapter 2 Page 17 The 1998 industry restructuring is resulting in increased competition in the downstream oil sector as the CNPC and SINOPEC start to compete for markets throughout the country. The downstream sector, however, has not achieved the efficiency gains that could be obtained by a second wave of sector reforms. Nor could it achieve such gains, because the presence of a duopoly is usually insufficient to create a functioning market. It is therefore both desirable and necessary to create the conditions for more competitors to take part in the market. The recommendations in the "road map" (see Table 4.1) aim at introducing supply from more players in the market to achieve the potential advantages from competition. By the end of the transition, the whole downstream sector, including oil refining, importing, and storage, would be fully open to capital, technology, and entrepreneurship from all sources, both Chinese and foreign. The downstream oil sector presents opportunities for smaller companies in the wholesale end of the business. Chinese capital should be mobilized and opportunities created for IOC participation through JVs in the wholesale segment (import terminals, storage, transport, and distribution). The IOCs can bring additional capital, management skills, and improved technology, including the opportunity for technology transfer to Chinese companies. In this, as in other parts of the petroleum sector, the IOCs can be expected to introduce high standards of environmental, safety, and health protection. In retail gasoline and diesel activities, restrictions on foreign majority participation should be removed to progressively enhance competition with the CNPC and SINOPEC in the retail sector. It is understood that the two companies are taking over smaller, privately owned retail outlets. If competition is to be effective and associated consumer benefits achieved, there would have to be rather large numbers of retail outlets carrying the brands of foreign companies. Typically they seek substantial representation that would support their infrastructure costs and make advertising, brand recognition, and other consumer relations activities worthwhile. It will be necessary to award a sufficient number of licenses, including sufficient retail stations allowed per license, to ensure a fully competitive environment in the retail gasoline business. The results could include job creation, the introduction of modern technologies, and marketing and improved service from both the incumbent suppliers and new entrants to the retail sector. In the refining sector, the competition will mainly come from the opening of the market for product imports. As well, the refinery sector should also be open for Chinese and foreign investments for rehabilitation and grassroots refineries when the current overcapacity disappears. This would introduce more suppliers of products to the retail sector and allow new investors in the retail sector to rely on their own supply sources. To provide Chinese companies with first-hand experience of open market competition, pilot projects for qualified Chinese oil companies and IOCs to operate in wholesale and retail markets should be initiated. Such projects should be put in place in two regions. The intent would be to provide Chinese companies such experience well in advance of the full downstream opening. In regard to taxes and to price setting, as a first step a study is needed of taxation on oil and gas products (including liquefied petroleum gas (LPG)) to examine both the effects and the fiscal revenue potential of the taxation instrument. The purpose of the Modernizing China's Oil and Gas Sector: Chapter 2 Page 18 study is to analyze the impact of such taxation on the structure of energy consumption and of the incorporation of environmental constraints. SDPC setting of oil products prices, as long as it is retained, should relate to maximum prices. The purpose is to remove a potential administrative obstacle to the working of competitive markets: benchmark prices tend to discourage the development of price competition. Many countries that practice price-setting of oil products apply maximum prices. Competition is then free to drive prices below these maximums to the benefit of the consumer. This will support the ultimate objective of creating a functioning market. Maximum prices for oil products should continue to be linked to international levels. Adjustments to these prices should take place at the same time as adjustments to crude oil prices under the remaining regulation to ensure that changes are made in step with each other. This would avoid causing undesirable fluctuations in refinery margins caused by changing the products' prices less frequently than those for crude oil. This would enable consumers to benefit from fair competition between products suppliers while still retaining the desired consumer protection effects in those sectors and regions where competition does not yet properly discipline selling prices. Municipal enterprises currently have an important role in the downstream sector. They will need to function in a more competitive environment. An important preparatory step that should be accelerated is corporatization of such enterprises and share issuance. It appears that progress on corporatizing municipal storage, distribution, and retail enterprises has been uneven and is not far advanced. More rapid progress is needed to enable the enterprises to attain competitiveness by the time the IOCs fully enter the market at the end of the transition. In this way, an important element of Chinese investment and entrepreneurship can hopefully be sustained, thereby making a contribution to overall market competition. The agreement between China and the United States for China's accession to the WTO provides for the removal of import quotas for oil products no later than 2005 and allows foreign companies to engage in wholesale and retail trade in crude oils and oil products by that date. The EU agreement sets out crude oil and product import quotas for nonstate companies, starting in the accession year for around 25 percent of current imports of crude oil and products. A fully functioning downstream market will require the reduction of oil products import tariffs and the phaseout of import and export quotas. As well, all investment restrictions in the wholesale and retail petroleum businesses will have to be removed after a transition period that gives domestic refiners time to adjust and achieve international competitive standing. The recommendations in the "road map" (Table 4.1) provides for a transition to accomplish this already-agreed opening. The progressive and eventually complete opening of the sector to investors, Chinese or foreign, necessarily raises the issue of the conditions for entry. In many countries, it is established practice for the government or a responsible agency to set out requirements that must be met by entities wishing to take part in certain petroleum activities. The requirements might relate to such matters as business incorporation, under predefined conditions; financial capability; and technical fitness to carry out oil and gas operations. To promote orderly competition, make the best use of natural resources and protect the public interest, it is a legitimate governmental function of the GOC to Modernizing China's Oil and Gas Sector: Chapter 2 Page 19 determine and implement such requirements, always provided they are not used as a mechanism to limit competition, for example to protect SOEs. The matter of "qualification" or "certification" of participants in oil and gas operations, as a regulatory function, is referred to in Chapter 3 and is elaborated in Annex 4. Box 2.4: Increased Downstream Efficiency The following actions (shown in chronological order) are proposed to increase the efficiency in the downstream oil sector: · Undertake a study of oil and gas products taxation and, to the extent relevant, prices and margins in the oil distribution trade (preparatory year). · Allow the SDPC to establish maximum prices for oil products to replace the existing system (from the beginning of 2001). · Allow Chinese and Chinese-foreign JVs to invest and operate in wholesale products markets (beginning in 2001). · Introduce crude oil and oil product import quotas for nonstate companies (2001). · Set up a scheme to gradually remove product import quotas and the licensing system (2001). · Allow qualified Chinese companies and IOCs to operate, on a pilot project basis, in wholesale and retail products markets in two regions (from 2002). · Remove restrictions (from 2003) on foreign majority participation in retail gasoline and diesel activities, and issue licenses in significant numbers. · Allow foreign companies to own majority interest in refineries (2003). · Accelerate and integrate the process of corporatizing municipal enterprises in the wholesale market with a program of listing shares in these enterprises (by 2005). · Reduce oil product import tariffs, eliminate import and export quotas and the licensing system (2005), and allow investors, both domestic and foreign, to operate in all sectors of the Chinese oil and gas sector (from the end of 2005). 2.5 Increased Downstream Gas Market Penetration Gas has high value in specialized applications and provides the basis for the new energy conversion technologies of gas turbine co-generation and combined cycle electric generation. It can contribute importantly to meeting the nation's large and growing needs for low-polluting energy forms. In some sectors, gas can be successfully marketed as the environmentally friendly, modern fuel. In North America gas provides nearly 30 percent of primary energy, in all of Europe gas provides about 20 percent, and even in Japan, totally dependent on imports, the proportion is 12 percent. Modernizing China's Oil and Gas Sector: Chapter 2 Page 20 The GOC's objective is to increase the share of gas in China's energy supply to 6 percent within 10 years. It will mean going from an annual consumption of some 20 Bcm today to around 80 Bcm a decade hence (for comparison, 80 Bcm is the size of Germany's 1999 consumption). The commercialization of such large new gas volumes over a rather short period will be a major challenge. Given the potential to increase the rate of utilization of domestic reserves, to increase those reserves, and to import gas from overseas as LNG and also from Russia by pipeline, the objective appears entirely feasible from a standpoint of adequacy of supply. Indeed, it would be reasonable to think in terms of much exceeding the 6 percent figure in the long term. To achieve even the 6 percent level, however, will require increased investment in existing production, more gas-oriented E&D, much capital spending on new and enlarged pipelines and distribution systems, and the removal of remaining obstacles to a functioning gas market. The steps that are described below aim at helping create the necessary policy conditions for these things to happen. The allocation of about one-quarter of natural gas supplies at low "in-Plan" prices distorts price signals to producers and consumers, and it has discouraged new supply and prevented rational and efficient use of gas resources. Since the early 1990s, the GOC has reduced the volumes under the in-Plan and increased the volumes under the out-Plan each year. The allocations should therefore continue to be phased out. As to concerns about adjustment, consideration should be given to the fertilizer plants that benefit from low "in-Plan" gas prices instead receiving direct government monetary subsidies. Such subsidies would have to be financially justifiable in terms of fertilizer industry economics and phased out over five years. The existing 10 percent negotiating flexibility in "out-Plan" gas prices is a step in the right direction, but market orientation of pricing needs to be further strengthened to allow all out-Plan prices to be freely negotiated. Today, many new projects are negotiated between buyers and sellers and do not fall under the in-Plan and out-Plan categories. Pipelines in the Tu-Ha Region in Western China are examples of such new projects. This will confirm and ensure the market orientation of all new gas development at the same time that prices and volumes in existing developments are being phased into a competitive environment. It will provide a clear signal of the GOC's long-term policy and will give an immediate incentive for gas development. Competition in the gas market and proper market functioning will develop gradually as the number of suppliers and buyers increases. In the initial stages of competitive market development, it may be necessary for the GOC, directly or through a regulatory agency, to provide guidance on how market principles should be applied in situations where sellers and buyers are not able to agree on prices and other terms. These are necessary conditions for making best use of an existing flow of gas to market and to provide correct price signals to gas producers, to ensure economically sound allocation of supplies to markets and to give incentives to gas development.3 3SDPC regulation of ex-refinery prices of light fuel oil to the fertilizer industry must be similarly phased out for essentially the same reasons. Modernizing China's Oil and Gas Sector: Chapter 2 Page 21 It is understood that the CNPC had "exclusivity" for wholesale gas transactions, and de facto it still dominates gas trade through ownership of most pipelines. To encourage E&D of natural gas, producers of all kinds--SOEs and PSC contractors-- should be allowed to market gas from their discoveries directly to consumers, such as power plants and industries. As well, they should have access to transportation on existing pipelines and be allowed to invest in new gas pipelines. Current gas pipeline rate design may frequently be a simple flat charge per volume transported. This is an out-of-date approach: it puts too much business risk on the pipeline, probably raises financing costs, and does not give the shipper an incentive to achieve high year-round load factors. More modern rate designs can encourage aggressive gas marketing and should therefore receive careful study. The foregoing steps constitute a suite of measures to support the GOC's 6 percent gas penetration target for 2010. Achievement of the 6 percent target will require a much more vigorous development than heretofore of domestic resources and probably the import of natural gas, some of which is already planned, as well. The agreement with the United States for China's WTO accession provides for the elimination of the natural gas import tariff from 2002. The policy and regulatory measures identified will need to be further refined. The planning of major pipeline projects required to achieve an 80 Bcm gas market will have to be identified, at least in conceptual terms. A start has of course been made with the announcement of the West­East Pipeline Project. And careful monitoring will be required of progress toward the 6 percent target, accompanied by a preparedness to examine and introduce further supportive steps if the ones set out here prove insufficient to the challenge. The urban gas distribution sector has several problems that need to be solved to increase gas penetration. Most important, the gas market planning should be promoted and developed based on the competitiveness of gas vis-à-vis other fuels. Secondly, gas distribution systems should be progressively corporatized and thereby liberated from the control and constraints of the municipal governments that own them. This will enable the distribution business to engage in a more active marketing, arrange its own financing, and address the problem of inadequate distribution margins because of the current pricing of gas. This should release an entrepreneurial spirit to help achieve the government's policy objectives for greater gas penetration in the energy sector. Analyses of other Options Considered The alternative to creating the conditions for private enterprises to develop and take part in the major supply projects that China will need is to commission one SOE or a group of SOEs to undertake at least some of the needed projects. Although there is nothing to prevent PetroChina from developing large new supply projects by itself, it should not be required to do so as an element of GOC policy for the following reasons: Modernizing China's Oil and Gas Sector: Chapter 2 Page 22 (a) The announcement of the West East Pipeline Project suggests that it is the GOC's intention that such projects should be undertaken with private sector foreign cooperation. (b) It would not accord with the principle of "allowing SOE managers to manage." (c) It would be contrary to the expectations of investors in the PetroChina IPO. (d) It would likely strain the financial resources of the SOEs and prevent them from undertaking other projects that might, in the judgment of their management, be more profitable. The alternative to allowing IOCs to market gas directly through access to existing pipelines or investments in new gas pipelines is to retain a strong role for a state entity (which could be a component of the CNPC) to act as a single national buyer and wholesale seller of natural gas. It would be required to treat all suppliers and buyers in a nondiscriminatory manner and to seek to optimize the business by obtaining the best prices for both suppliers and buyers. This is somewhat the former European model exemplified today by Gaz de France. It is not recommended for the following reasons: (a) The competitive market approach will yield superior results for both suppliers and buyers in terms of timing, pricing, and expansion. (b) Funding of investments would be difficult, which would slow gas development. (c) This model has been or is being abandoned in the most industrial countries. Conclusion on Policy Options This consideration of policy options therefore finds them to be deficient. Therefore, no major alternative course of action is available. Gas penetration must be achieved by fostering the development of competitive markets and encouraging the participation of IOCs in the various gas businesses. Conversely, there is a need to recognize both the limited role for the state in the sector and the fact that the state has other and broader responsibilities in terms, for example, of establishing macroeconomic policy and dealing with national social security issues. Consideration of Measures to Supplement the Working of Competitive Markets Although the measures identified, together with enhanced E&D, will create a much more favorable environment for gas penetration than presently exists, no assurance exists that they will be sufficient to secure the targeted gas penetration. Supplemental measures may therefore be required to support the marketing of gas (and may anyway be desirable in their own right because they would help reduce environmental costs). These include the following: (a) tightening emission controls in respect of all fuels, particularly in urban areas; (b) taxing the use of high-sulfur fuels, at least in areas where atmospheric pollution is a particular concern; (c) phasing out the use of coal for commercial and industrial use (except electricity generation) where natural gas service is available; (d) providing loans and grants toward the capital cost of gas conversion in some public and residential sectors; and Modernizing China's Oil and Gas Sector: Chapter 2 Page 23 (e) ensuring that other energy policies, for example regarding electricity generation, do not present obstacles for gas penetration. The rate of gas penetration must be carefully monitored against the target. Government authorities should track the planning and development of gas supply, transportation, distribution, and conversion projects by the enterprises. Actions along the above lines should be carefully studied and, if they are found acceptable, promptly initiated if the rate of project development falls short of what is needed to achieve the 6 percent goal by 2010. Box 2.5: Increased Downstream Gas Penetration The following actions are proposed to achieve the goal of increased gas market penetration: · Study how to further phase out in- and out-Plan prices (2000). · Phase out the allocation of gas volumes and phase out (2001) the use of in-Plan prices. · Create and refine the conditions for private enterprises to take part in the development of gas mega- projects (2000 onwards). · Promote market planning and development based on the competitiveness of gas vis-à-vis other fuels (2001). · Study, and bring to a state of readiness, supplemental measures to support gas marketing (2001). · Provide open access to new and existing gas pipelines (2002, see Box 2.2). · For new projects, gas prices should be negotiated between buyers and sellers (2001). Modernizing China's Oil and Gas Sector: Chapter 3 Page 24 CHAPTER 3: REGULATORY REFORM: PROMOTINGTRANSPARENCY, INVESTMENT, AND COMPETITION 3.1 Role of Regulation Regulation is recognized as an essential function in a modern petroleum economy, and governments dedicate substantial resources to it. For example, the U.S. Minerals Management Service, which regulates all aspects of oil and gas in the federal offshore area, mostly in the Gulf of Mexico, has 1,800 employees. The Alberta Energy and Utilities Board (AEUB), which was established in 1937 as the Oil and Gas Conservation Board of Alberta, employs about 650 people and has an annual budget of some $40 million. As a result of the 1995 merger into the AEUB of the province's Public Utilities Board, which dated from 1915, the AEUB is now responsible for technical and economic regulation of the whole oil and gas (and electricity) industry in Canada's major petroleum-producing province. The scope of regulation is broad: it covers a whole range of activities from the approval of geological and geophysical exploration programs to the operation of gas distribution networks serving households. Regulation can start with the initiation of projects and extend to their eventual abandonment, facilities removal, and cleanup. It is important to take note of the range, nature, and purpose of oil and gas regulation in making decisions on the structure, staffing, and resourcing of oil and gas regulatory organizations. Regulations are an essential component of the oil and gas legal framework. Some are issued by the government, and some by the regulator using the authority the government has given it. In either case, the purpose is to provide the necessary detailed interpretation and application of the basic oil and gas law (which is pending in China) to specific industry and sector situations. Both the regulator and the industry are then bound by these regulations. Because they are created by government orders or by orders of the regulator, they may also be changed in a similar way and are therefore less stable than primary laws, but more flexible. Proper drafting and implementation of regulations will guide development of the oil and gas sector and will serve as the basis to promote investment by IOCs. Modernizing China's Oil and Gas Sector: Chapter 3 Page 25 3.1.1 The Nature of the Regulatory Body The modernized regulation of China's oil and gas sector would be designed with the approval of its politicians and implemented by a new agency situated within the overall government structure. That regulatory body's activity would be comprehensive in scope (see section 3.1.3), separated from the oil and gas policy function (section 3.2.1) and, insofar as specific decisionmaking is concerned, independent of that function (section 3.2.2 and Box 3.1). Its rules and processes would be publicly known, responding to the principle of transparency (section 3.2.4) and would be grounded in a new legal framework (section 3.2.5). There are options for the structure of the regulatory body (section 3.3.1) and policy issues respecting its functioning need to be addressed (section 3.3.2), although the powers to take discretionary (as opposed to administrative) decisions should be entrusted to a small group of well-qualified commission members who are appointed with security of tenure for staggered terms of, say, three to five years, subject to strict conflict-of-interest guidelines, supported by an expert staff and provided with adequate resources. A senior minister would be the contact point for the regulatory body at the State Council level: he would be knowledgeable about its activities, budget, and the like, and would publicly communicate general policy direction to the agency's head, but would not interfere in its decisionmaking in individual cases. 3.1.2 Need for Regulatory Change As was noted earlier, significant emphasis is now being placed on the need for a coherent gas policy with accompanying gas regulations. If the ambitious plans for gas are to be realized (meeting a target of 6 percent in the fuel mix by 2010), the need for clear policy decisions and related regulations is urgent. The regulations and their implementation must be soundly based, fair, and transparent. This will help create a level playing field for investors. It will help bring about a market conducive to attaining the government's policy goals, partly by attracting foreign investment, which is a key driver in developing the sector. Presently no coherent regulatory framework exists for China's oil and gas industry. As a result of this deficiency, there is no clear mechanism for guiding development of the sector. The harm has touched domestic and foreign companies alike and threatens to slow much-needed growth of the sector. By implementing a program of regulatory reform, carried out in tandem with the program of sector structure reform as described in Chapter 2, future development can be promoted. The case for regulatory reform was briefly reviewed in Chapter 1 in the context of examining the general case for comprehensive reform. The particular case for new-style regulation is presented in the following sections. The essential argument is that regulation carried over from a centrally planned economy cannot serve the needs of a socialist market economy for the following reasons: (a) Old style regulation is not compatible with the development of market forces. Certain remaining controls--for example, on oil and gas prices, on the flows of these Modernizing China's Oil and Gas Sector: Chapter 3 Page 26 commodities, and on investments by enterprises--discourage the working of market forces and prevent the managers of enterprises from acting in the best interests of the business owners. Therefore, to bring about sector opening, these controls must be adjusted and eliminated. (b) Old-style regulation did not pay adequately attention to health, safety, and environmental protection. Existing regulation in the fields of human health, safety, and environmental protection, even where it is adequate, is not comprehensively enforced under the old-style regulatory paradigm. Therefore, a high international standard of technical regulation needs to be introduced and fairly implemented by an independent authority. (c) There are "gaps" in old style regulation. There are areas where the state has a legitimate role, but which are not covered by old-style regulation. One of them is the oversight of oil and gas-producing operations to prevent waste of the state-owned resources where there is poor reservoir management or unnecessary flaring of gas. Another area is the regulation of pipelines to ensure that they provide access to any qualified parties that wish to have their oil and gas transported. (d) The institutions for sound regulation are lacking. Since old-style regulation is diffused within government, parts of several ministries and agencies have oil and gas regulatory responsibilities. Conversely, there is no organization where regulation of this sector can be based and no provision for coordination of present regulatory activities affecting the sector. (e) Old-style regulatory processes are not transparent. Regulatory processes carried over from the era of central planning cannot satisfy the standards required of new-style regulation. For example, they are often not properly separated from the policy function of government; the SOEs may retain a role in them; they lack transparency; and they do not ensure that decisions in individual cases will be free from political interference. The situation presented by old-style regulation is unacceptable in the long term and must be corrected by a program of regulatory reform if a positive market environment is to be created. Like sector structure reform, this program should be carried out in accordance with the principle of a flexible and pragmatic transition. Regulatory reform is a necessary counterpart of structural reform, supporting and facilitating it. Regulatory reform therefore has to be synchronized with structural reform. 3.1.3 Scope and Depth of New-Style Regulation New-style regulation answers the question, "What is needed to create a regulatory environment conducive to a competitive, market-based petroleum industry?" New-style regulation means "government control and direction of those activities of business enterprises that are not subject to publicly acceptable disciplining by competitive forces as market opening takes place." Modernizing China's Oil and Gas Sector: Chapter 3 Page 27 Broadly, four areas of activity requiring regulation are not adequately covered by market forces. These include the following: 1. Technical regulation involving mainly engineering skills and including health, safety, environmental protection, and petroleum reservoir management. 2. Economic regulation of prices, and access and quality of service, typically for natural monopolies, such as pipelines and gas distribution systems. In addition, two other responsibilities may be placed on the oil and gas regulator: 3. Mineral resources and fiscal includes the administrative functions related to the management of petroleum mineral resources, leasing rights to explore and produce them, the collection of production royalties and similar revenues for the state, and maintenance and provision of appropriate access to the related data inventory. 4. Qualification of participants in oil and gas operations to ensure their technical, financial, and administrative fitness (again, refer to Annex 4). A comprehensive listing of proposed regulatory activity is set out in Annex 5, and further detail on issues of environmental regulation is presented in Annex 6. 3.2 Regulatory Framework: Principles to Drive Investment Five principles should be applied in developing a new oil and gas regulatory framework for China: (a) separation of regulation from policymaking, (b) independent regulatory decisionmaking, (c) removal of policy and regulatory responsibilities from SOEs, (d) transparent regulation, and (e) a sound legal framework. After the implementation of a regulatory framework based on these principles, a "new regulatory culture" will emerge and be characterized by even-handed application of regulation to all enterprises and stability and predictability of decisionmaking. This means that all parties affected can expect the same basic regulatory approach to remain in place for a long time, which will assist in business planning, whereas predictability means that regulators, when dealing with similar factual circumstances, will take essentially similar decisions, thereby increasing business confidence. 3.2.1 Separation of Regulation from Policymaking Modernizing China's Oil and Gas Sector: Chapter 3 Page 28 Historically comprehensive control of an enterprise's activities was a key feature of a centrally planned economy. In this model, the policy and regulatory functions were merged. In the changing conditions of the increasingly dynamic socialist market economy, however, an enterprise's activities are increasingly controlled by the market. Those that are not controlled by the market are subject to independent regulation. The critical policy lever is no longer the approval of specific investments and activities. Instead it is the determination of the broad policy environment in which particular sectors, as well as the economy as a whole, function. The policy role regarding oil and gas in a socialist market economy relates mainly to the following kinds of issues: (a) long-term security of supply; (b) management of domestic resources; (c) ensuring the fair operation of markets; (d) creating a favorable environment for foreign investment; and (e) sector employment and social welfare issues. In each of these cases, policies and policy principles are defined by government. Their implementation is, to a large extent, carried out by some form of independent regulation. To effectively achieve this, however, the two functions must be organizationally separate. The policymaker cannot make regulatory decisions affecting individual enterprises. The regulator does not have a role in developing broad policies, even though it takes account of them in its own specific decisionmaking. 3.2.2 Independent Regulatory Decisionmaking Regulatory decisions should be taken only by the regulator, with regard to the broad policy environment, which should otherwise act independently of the policy side of government. In some jurisdictions, however, the policymaker retains veto power over very important decisions of the regulator, such as whether to allow large imports or exports of gas or the construction of major pipelines. Other features and requirements for independent regulation include the following: (a) Enterprises should not be able to improperly influence the regulator. (b) There should be high, mandated standards of regulatory behavior. (c) There should be security of tenure for the regulator to reduce fear of job loss if decisions taken are unpopular with enterprises or with government. (d) "Fees-for-service" or levies on industry activity, paid to the regulator to assure it has the necessary human and financial resources to adequately fulfill its responsibilities as opposed to being financed by the government budget. Independent regulation carried out under these conditions produces several benefits. For the public, it will increase confidence, for instance, that environmental regulation and the control of monopolies is not subject to outside influence. For the Modernizing China's Oil and Gas Sector: Chapter 3 Page 29 enterprise, it will improve the investment climate by helping create a level playing field for all participants. Box 3.1 provides a summary of the key principles of independent regulation. 3.2.3 Removal of Policy and Regulatory Responsibilities from SOEs The commercial playing field will not be level as long as the SOEs have regulatory responsibilities, whether to self-regulate or to regulate competitors, and have a role in policymaking. Policy development is the exclusive preserve of government policymakers. Self-regulation, however conscientiously carried out, holds the potential for abuse. It is unacceptable for SOEs to have any role in regulating competitors. And, again, the managements of SOEs must be freed up to concentrate on commercial activities. The solution is to remove any policymaking or advisory functions from the SOEs and to transfer remaining regulatory functions to a national regulatory body as soon as possible. 3.2.4 Transparent Regulation "Regulatory transparency" means that the regulated entity and parties who have a legitimate interest in its regulation should know all the rules and processes under which regulation will be carried out. Unless commercial secrets are involved, the facts in any disputed cases should be made public, together with the regulator's decision and the reasons for it. An example of transparent regulation would be the public filing of an application for a new gas pipeline transmission rate. Any parties who wanted to support or oppose the application would have to do the same. If a hearing were required to examine these filings and hear arguments about them, it too would be public. And the regulator's decision would be taken on the basis of that evidence and those arguments. The reasons for its decision would be published. The regulator will as well report annually to the public on its activities. Transparency, like independence, is an important factor that will develop confidence on the part of enterprises and other stakeholders that the system is fair. It will as well contribute to the attributes of consistency and stability in decisionmaking that are hallmarks of good regulation. 3.2.5 A Sound Legal Framework For new-style regulation to succeed, a legal framework is required, compatible with the features of a socialist market economy, and which will establish and reinforce the regulatory system. Modernizing China's Oil and Gas Sector: Chapter 3 Page 30 Box 3.1: Principles of Independent Regulation It is important for the regulator to make discretionary decisions, such as on pipeline rates and access terms, solely on the basis of the facts of each case, as presented by the applicant and interested parties. A "discretionary decision" is generally one in which the decisionmaker can choose among alternatives. For example, different rates of return on investment by a pipeline company may determine the prices of the commodity or services related to it. It contrasts with an "administrative decision," which is made on the basis of whether an applicant has complied with a predetermined list of mainly factual criteria or conditions. Independence in discretionary decisionmaking is important to investors in and users of regulated facilities. It assures them that covert pressures from any quarter will not influence decisions in specific cases, political or commercial. This is an important confidence-building factor in the regulated utility industry. To maintain independence, the regulator should not receive instructions from the policy side of government, and all communications and evidence put before the regulator should be public. The eventual decision should demonstrably be made only on the basis of that public information. Independence is also secured through the appointment of the regulator for a fixed term (three to seven years) and by meeting the costs of regulation through fees-for-service or levies on industry activity (pipeline throughputs, for example), so that the regulator is not dependent on government budgetary decisions. An independent regulator may still be subject to influence from government policy. It is considered acceptable, indeed desirable, for the regulator to take note of the government's policy statements, whether they relate to the economy at large or to the regulated sector specifically. Canada provides two examples of this. First, in the early 1980s, during a period of rapid inflation, the government announced that it wanted all its decisionmaking agencies to put government-prescribed ceilings on price increases for all products whose prices were regulated. Those ceilings were taken into account by the energy regulator in pricing decisions. Second, in 1985, the government announced a change in national energy policy that henceforth was to be market-oriented, rather than command-and-control. The energy regulator responded by removing oil controls, allowing gas producers greater access to export markets, and requiring pipelines to grant access to third parties, so that individual sellers and buyers of gas could deal with each other directly. A properly designed legal framework will give the policymaker proper supervisory powers over the regulator while at the same time giving the regulator independence in dealing with individual cases. It will make broad provisions for transparency of regulatory processes, and it will provide appropriately for appeals from regulatory decisions flowing from those processes. The various levels of government-- State Council, the regulator, and provincial authorities--will be suitably equipped with all the legal instruments needed to make modern regulation work. The legal framework is required to give permanence and certainty to new-style regulation. Conversely, it will make it clear that old-style regulation will not be revived. These are additional factors that will increase the confidence of the public and of investors, which are addressed below. Modernizing China's Oil and Gas Sector: Chapter 3 Page 31 International Regulatory Best Practices To provide some perspective on the content and results of modern oil and gas regulation, examples are provided in Annex 5 of international best practices of structural and regulatory reform. They relate to countries that, in the last 10­15 years, have achieved successful and productive sector restructuring involving the introduction of new regulation or, in the case of Canada, the adaptation of existing regulation to new policy objectives. 3.3 Proposals and Objectives for Sector Regulation The final objective by the end of 2005 is to achieve a fair, comprehensive and permanent oil and gas regulatory structure for both the up- and downstream petroleum industries. This will provide the following: (a) efficient petroleum mineral resource administration and related fiscal management; (b)high standards of technical regulation from the standpoints of sound engineering practices and of health, safety, and the environmental protection; (c) effective economic regulation of monopolies in regard to their rates, services, and capital projects; (d) monitoring of the operation of markets for competitive behaviors; and (e) fair qualification of enterprises wishing to take part in sector activities. Transparent processes should be instituted that provide comprehensive information for all parties affected by regulation and regular reporting to the government and public on regulatory activities and their results. This new regulation will both facilitate and support sector structure change. 3.3.1 Organizational Options One option is to create separate up- and downstream regulatory commissions ("the regulatory commissions") from the end of 2005. The specific functions of such a structure are listed in Annex 7. Establishing separate commissions is recommended for a number of considerations: (a) Industry segments are differently organized and will eventually be composed of largely different companies. (b)Regulation of the downstream has a much larger discretionary component. (c) Different types of public processes will be required, and those processes are likely to be significantly different up- and downstream. (d)The technical-regulatory requirements of the segments call for different technical and managerial skill sets. (e) The government, as owner and lessor of the mineral resources, has a beneficial interest in the way these rights are managed, which is fundamentally different from its interest in regulation of the downstream industry. Modernizing China's Oil and Gas Sector: Chapter 3 Page 32 A second option would be to have one regulatory commission with two "deputy regulators" dealing with the up- and downstream. 3.3.2 Policy Issues to Be addressed No matter which option is selected, there are several important broad policy issues that will need to be addressed, for example, the following: (a) the extent of the commission's (or commissions') jurisdiction, in terms of the areas of activity set out in Annex 2, for example, who should be responsible for administering petroleum mineral rights; (b)the degree to which the commission(s) should be allowed to exercise discretion in matters of regulatory policy, for example, whether it should be the commission(s) or the policymakers who will decide which consumers will be allowed to choose their own gas suppliers; (c) the extent to which the commission(s) should be autonomous in regulatory decisionmaking in specific cases, for example, whether they should be allowed to authorize large new investments without any recourse to the policy side of government; (d)the provisions for the policy side of government to communicate with the commission(s), for example, to convey to the commission(s) generic energy, oil, or gas policy advice without interfering or appearing to interfere in decisionmaking in specific cases; (e) the arrangements for appeals from decisions of the commission(s), for example, what decisions could be appealed, on what grounds, and to what level, inside and outside the commission(s); (f) the relationship between the new regulatory commissions and existing agencies that have exercised elements of the responsibilities that are to come under the commission(s); and (g)the question of delegation of authority to the regional, provincial, or municipal levels, an issue that is important enough to require separate discussion here. Delegation of Regulation below the National Level Administrative structures already exist, particularly in respect of aspects of gas industry technical standards and commercial arrangements, at the provincial and municipal levels. On the one hand, these structures and the people who run them are experienced, adapted to local conditions, and familiar with the entities subject to their oversight, such as urban gas distribution systems. On the other hand, this form of administrative control has, broadly described, been unduly responsive to local social and political conditions, resulting in the distribution enterprises' being compelled to operate noncommercially and prevented from properly playing their important role in an expanding national gas industry. Modernizing China's Oil and Gas Sector: Chapter 3 Page 33 In a number of federal states, such as Australia, Canada, Russia, and the United States, the constitutional division of powers gives the state or provincial governments responsibility for economic activities that are wholly within their boundaries. As a result, in these countries, intrastate oil and gas activities are regulated at that level. This means activities, such as oil and gas well drilling and gas distribution. The federal (national) government's responsibilities relate to such activities as offshore oil and gas and gas transmission systems that cross state boundaries. In most cases, state or provincial regulation is longstanding (see, for example, the reference to the AEUB under section 3.1.1) and is carried out responsibly. Quite apart from the constitutional division of powers aspect, there is much to be said for the local regulation of activities that are purely local in character. China, however, is not a federal state. Moreover, the indications are that local administrative control of natural gas has not been carried out well, and the local authorities have not been responsive to existing central direction, for example, SDPC's price directives. We, therefore, cannot be optimistic that the changes required by new- style regulation will be readily acknowledged or adopted by existing local administrations. If foreign corporations are going to invest in new gas distribution businesses, a field that is now open to them, they will have more confidence in the stability and fairness of a national regulator than of a provincial or municipal one. The matter of downward delegation of regulatory authority in China is clearly politically sensitive and administratively complex. It therefore requires further study. However, if delegation takes place, then as a minimum the regional, provincial, or municipal levels should be required by law to observe national standards for regulatory processes and national guidelines in such areas as return on investment. Unless this is done, the country's urban gas distribution systems will not be able to fulfill their important role in fostering penetration of the energy market by natural gas. Technical Regulation Should Become More Vertical Today, the administration of technical regulation of all kinds is dispersed among several agencies and the SOEs. In the future, the administration of technical regulation of all kinds will be concentrated rather than, as at present, dispersed among several agencies and the SOEs. It will be carried out objectively, with efficient enforcement, to high international standards. Key aspects include the following: (a) The State Environmental Protection Administration (SEPA) will continue to set environmental standards on a national level. (b) Oil and gas regulation will generally be provided through a "single window" national regulator. This means that the regulator normally can approve all phases of an oil and gas project. (c) Potential conflicts between the single regulatory authority's sector-specific "vertical" regulation standards and generic "horizontal" regulation can be eliminated by careful definition of jurisdictions, by definition of tasks within those jurisdictions and, where appropriate, by giving the oil and gas regulator Modernizing China's Oil and Gas Sector: Chapter 3 Page 34 the authority to implement the standards set by the "horizontal" regulator. (d) For example, oil and gas industry sulfur emissions, handling and disposal of dangerous chemicals, and the use of radioactive materials would be regulated, directly or indirectly, by the responsible "horizontal" regulators. Gas flaring, return of produced water to predetermined geological formations, and cleanup of well sites, all of which are activities peculiar to the oil and gas industry, would be handled by the "vertical" regulator. (e) Even where standards are developed by another agency, efficiency gains can be achieved if the specialized sector regulator is authorized to implement them, thereby maintaining the "single window" concept. (f) Where appropriate, administration of regulations will be carried out at a regional or provincial level, but always on the basis of national standards for regulatory requirements and processes, including enforcement. Authority to grant licenses to one agency will increase the effectiveness of the regulatory system. SEPA still has an important role to play. In addition, a "one window" approach provides more efficient regulation than a regulatory structure where responsibilities are dispersed among many agencies Economic Regulation Should Diminish over Time Economic regulation of the oil and gas sector will diminish during the transition as many existing controls are removed and prices and flows of oil and gas become regulated by the working of competitive market forces. At the same time, modernized regulation will be introduced in those parts of the sector where regulation is needed as a substitute for competition. This will facilitate and encourage the working of competitive markets for oil and natural gas, particularly the latter, as commodities. 3.4 Transition Period Tables 3.1 and 3.2 present a short summary of implementation tasks for regulation both during the transition period of 2000­05 and thereafter. There are two major differences between the pre- and postregulatory environment: the change from granting import and export licenses to a monitoring-only approach, and current regulation of oil and gas price tariffs for upstream products will be eliminated by 2005. Modernizing China's Oil and Gas Sector: Chapter 3 Page 35 Table 3.1: Regulatory Areas during Transition, 2000­05 Activity Mineral Imports and Prices and Service Major Technical rights and exports tariffs standards project fiscal approval Upstream* Oil Yes License Yes Yes Yes Gas Yes License Yes Yes Yes Downstream* Pipelines Yes Access Yes Yes Refineries Yes Yes Distribution Gas Yes Yes Franchise Yes Oil retail License Yes Local Yes Note: Blank cells indicate "not applicable." Table 3.2: Regulatory Areas after Markets Are Functioning, Post 2005 Activity Mineral Imports and Prices and Service Major Technical rights and exports tariffs standards project fiscal approval Upstream* Oil Yes Monitor No Yes Yes Gas Yes Monitor No Yes Yes Downstream* Pipelines Yes Access Yes Yes Refineries Yes Yes Distribution Gas Yes** Yes Franchise Yes Oil retail Monitor No Local Yes * "Upstream" includes exploration, production, gathering and processing or purification. "Downstream" includes all activities beyond the gas processing plant and beyond the entry point of the trunk crude oil pipeline. **Distribution tariff, not gas selling prices. Note: Blank cells indicate "not applicable." In the following sections, the specific tasks to be completed during the period 2000­05 are presented. Modernizing China's Oil and Gas Sector: Chapter 3 Page 36 3.4.1 Organization and Relationships in the Transition Period Decision is needed on the responsibility focus for the implementation of the new sector and regulatory structure. This responsibility area includes confirming and, where necessary, adjusting the implementation agenda, as well as overseeing all studies, recommendations, monitoring, and interim regulatory operations. The first, vital, organizational step is to authorize an "Reform Bureau", to be given both the responsibility and the authority of a "change champion", taking the senior decision making and oversight functions for both structural and regulatory change in the oil and gas sector. The Director of this Bureau has the responsibility to report to the State Council. To ensure that the Director of this organization takes an unbiased approach to such matters as organizational design and staffing, it would be made clear from the outset that he or she would not occupy a senior position in the future commission(s). Organizational Structure It is necessary to create an interim regulatory organization to provide for the coordination, according to new objectives, of existing regulation during the transition (for example, oil products price regulation) and for the implementation of new regulation (for example, provision of open-access pipeline transportation). This organization should probably also be responsible for monitoring and reporting on the progress of regulatory and structural change. It would not be feasible to immediately create a new permanent regulatory organization. To do so, the legal and administrative task would be large and time- consuming, and the expenditure of time and resources might be at the expense of time devoted to initiating practical regulatory reform. The preferred approach is to have the "chief interim regulator," with deputies for the up- and downstream, empowered to do this job. The chief interim regulator would, under this concept, be completely in charge of managing regulatory change at all levels. He would be responsible for obtaining the cooperation of departments and agencies in the transition process, and he would report to the Director of the Reform Bureau. Staffing of the interim regulatory organization is clearly a vitally important issue. Whether or not the chief interim regulator idea is pursued, a dedicated, enthusiastic group of people needs to staff the work of regulatory change. This "core team," which might report through deputies for the up- and downstream, would receive immediate training including, for its legal staff, an understanding of current laws and regulations for oil and gas. Initially comprising perhaps 15 professionals, the team would be carefully selected from the cooperating departments and agencies. Periodically its size and training needs would be reviewed and any changes promptly acted upon. If the concept of interim regulation under a chief interim regulator is adopted, it will be vitally important for it to succeed. A significant failure in this transitional instrument for regulatory reform could prejudice the whole program and jeopardize the Modernizing China's Oil and Gas Sector: Chapter 3 Page 37 chances of successful implementation of the permanent regulatory commissions. Careful attention will therefore need to be given to ensuring the conditions for success, including particularly the matters of providing proper authority to enable the chief interim regulator to discharge his functions, and adequate resources to do so. Organizational Relationships Carefully selected interdepartmental and interagency relationships for the functioning of the interim regulatory organization will have to be in place. Therefore, for each area of regulatory activity, transitional contact ministries and agencies must be identified. The choice of ministries and agencies will have to be designed to cover regulatory activities that will eventually be abandoned, as well as new ones. The recommended permanent regulatory commissions should be authorized, empowered, organized, staffed, and resourced, and be functioning by the end of the transition. Those components of the SOEs that have been responsible for aspects of technical regulation (the "institutes") will have to be organizationally divided from the SOEs and given an independent status. Ultimately their functions and staff should be transferred to the permanent regulatory commission(s). Responsibility for Developing the Permanent Regulatory Scheme Consideration should be given to the question where to focus the task of developing the permanent regulatory scheme. This would involve policy, techniques, legislation, and organization. It could be made a responsibility of the interim regulatory organization (containing a growing body of information and expertise, but also engaged with ongoing regulation), or it could be given to a separate organization, not having ongoing operational responsibilities. Box 3.2 and Table 4.1 summarize the recommendations. Box 3.2: Summary of Organizational Actions for 2000 Key actions include the following: · Ministerial and vice ministerial Director of the Reform Bureau should be identified for market structure and regulatory reform. · A "chief interim regulator," together with deputies for the up- and downstream, should be selected and empowered. · A multidisciplinary "core ream" should be selected to support the interim regulator, reporting through the two deputies, and should receive immediate training including, for its legal staff, an understanding of current laws and regulations for oil and gas regulation. · Transitional contact ministries and agencies should be identified for each area of regulatory activity to be carried out in the transition. · Appropriate steps should be taken to put in place a process to continuously review, appraise, and report to the policy level on the progress of the transition and experience with interim regulation. (2001) Modernizing China's Oil and Gas Sector: Chapter 3 Page 38 3.4.2 Required Studies to Prepare for Regulatory Change A suite of studies needs to be pursued and completed at an early stage in the regulatory transition. They will therefore be carried out in advance of the work on implementation of the permanent regulatory structure. They include the following studies: 1. Recommended changes to existing regulation. This includes aspects of upstream technical operational and environmental regulation by intermediaries ("the institutes") that have been separated from the SOEs. 2. Inventorying and mapping of the existing regulatory structure. 3. Relationship with other organizations. In respect of both the interim and the permanent organizations, studies will have to be undertaken and decisions made in regard to such matters as the following: (a) positioning within the structure of the GOC; (b) definition of their relationships with other departments and agencies, including SOEs and organizations presently affiliated with the SOEs (the "institutes"); (c) authority (what they can do and to whom); (d)internal structure, in a broad sense (detailed organization should be left to the respective managements); (e) staffing in terms of the numbers and where these staffs will be obtained; (f) available resources and the means to provide those resources (for example, charging of fees for regulatory services provided, levies on the production of regulated entities such as pipelines); and (g) appropriate division of regulatory responsibilities between different levels of government (central, provincial, and local). 4. Definition of the regulatory policies for each of the four main areas of regulation. For example, as to mineral resources licensing, should it be a mechanical process or discretionary? In the area of technical regulation, is it to be "prescriptive" or "objectives related?" In regard to economic regulation, should pipeline rates be determined by a "price cap" methodology or by some kind of cost-of-service approach? As to "qualification," how should the principal criteria for taking part in petroleum activities be defined? 5. Identification of the basic regulatory techniques. Corresponding with certain regulatory policy decisions, how-to decisions will be required. For example, if technical regulation is to be prescriptive, how are the relevant standards to be developed and what use should be made of international standards (API, ISO)? If pipeline rates are to be determined by the cost-of-service approach, what data need to be collected and in what form to provide the accounting basis for this kind of regulation? In regard to both Modernizing China's Oil and Gas Sector: Chapter 3 Page 39 regulatory policies and regulatory techniques, consideration has to be given to mobilizing resources to assist the above decision processes. 6. Design of and processes for legislative implementation. As to legislative design, decisions will be needed on the degree to which regulation should be embodied in laws (that are difficult to change) or regulations (that can be changed more easily, thereby providing "flexibility") and on the regulation-making power that is to be retained by the policymaker compared to the powers to make regulations that are granted to the regulator. Consideration will also need to be given to the extent to which existing legal authorities can be adapted to meet new regulatory needs as compared to the desirability of making a "fresh start" with entirely new legislation. Once these studies are complete, arrangements will be needed for the legal "tracking" of regulatory reform activities and for legislative drafting instructions stemming from them. The creation and enactment of legislation presents a complex set of tasks that will have to start in the preparatory year with the briefing and familiarization for the legal staff of the interim regulatory organization. By 2005, all the laws, regulations, guidelines, and any other instruments necessary to fully implement the objectives of regulatory reform, including the establishment of the permanent up- and downstream regulatory commissions and including as well legislation to amend or revoke existing statutes, must be drafted and enacted. 3.5 Conclusions on Regulatory Reform When the regulatory reform tasks have all been accomplished in an integrated manner at the end of the transition period, the GOC and the country's important oil and gas sector will be equipped with a thoroughly modern regulatory regime designed to a high international standard. In fact, to the extent that the regime is established on first principles and built up as an integrated whole, it could be superior to the regimes of some other industrial countries that reflect mutations taking place over many decades. Creation of this regime is both a necessary condition for successful structural reform and a means to support such reform. In summary, key areas to address include the following: (a) Elimination of old and inappropriate regulation is critical. Current regulations pertain to a planned economy approach, whereas China is in the midst of a conversion to a socialist market economy. (b)Recognition of three distinct types of regulation, mineral rights and fiscal, technical, and economic. Each must be addressed individually. (c) Separation of regulation from policymaking is essential. By doing so, conflicting objectives of government policy and the free hand of market development will be eliminated. Modernizing China's Oil and Gas Sector: Chapter 3 Page 40 (d) New-style regulation must be independent and transparent. No SOEs should be involved in regulation because of the potential conflict of interest, and transparent decision making must exist so that IOUs fully understand the process and rationale. (e) A sound legal framework is needed. The legal structure that will support the required regulations and laws must be clear and coherent, and must adhere to international best practices. China's Oil and Gas Sector: Policy, Structure and Regulation: Chapter 4 Page 41 CHAPTER 4: SUMMARY: CHALLENGESAND PHASED IMPLEMENTATION 4.1 Major Challenges Sector reform and regulation are the principal issues for the oil and gas sector and will be deciding factors in achieving a fully functioning competitive market. Based on the objectives for sector reform and new-style regulation of the oil and gas sector, numerous operational tasks must be completed to achieve those objectives. These tasks present formidable challenges in such areas as government organization, staffing, and the design and development of specific elements of regulation. To accomplish this, the GOC will need to confront major challenges, recognize the need for transition, and implement a logical "road map" for future actions. GOC recognizes that the reform needs to be implemented with WTO agreement in mind, but with due concern for the current sector structure and operations. The transition from a command-and-control approach to a more market-based approach is a tremendous challenge with many potential pitfalls. Careful planning and a phased implementation, with provision for further studies and for specific decision points along the way, will go far toward reducing the margin for errors. Probably the most difficult challenge to overcome will be the need to change mentalities and behaviors. Business managers used to a government-controlled sector have to adapt to a different set of market dynamics and be inspired by performance and results. Rather than focusing on central planning and control of the economy, government officials will get their job satisfaction from setting general frameworks, from discouraging antimarket behaviors, and encouraging market-based efficiencies, and then from monitoring the results. All this will put a lot of stress on the whole system. Change will therefore not be accomplished without difficulties, but the potential gains are of great importance for China and far outweigh the risks. Compared to a "business as usual" case, the oil supply balance will be improved, the contribution of gas will be increased, atmospheric pollution will be reduced, new capital and entrepreneurship--bringing with them new technologies--will flow into the sector from China and abroad, high-value new employment will be created, and all classes of consumers will be better served in terms of quality and price. In the light of these favorable prospects, it will be well worthwhile to deal with the challenges and accept the risks posed by the transition. 4.2 Need for Transition and Legal Framework The introduction of a market-based approach cannot be accomplished overnight. Transition will have to be phased. The creation of new legislation is a key activity for the transition: when approved by the State Council, it can be implemented on a temporary basis during the transition. However, the legal and administrative task is large and time- China's Oil and Gas Sector: Policy, Structure and Regulation: Chapter 4 Page 42 consuming and should not delay sector reform and regulatory change. Nevertheless, actions must be initiated on the introduction of laws giving the legal basis for oil and gas activities and regulation in the sector. Such laws are the foundation and basis for the legal framework and will act to secure and complement regulations. The GOC will have to promulgate laws in which the elements of the new policy and regulatory framework are established that include the following goals: (a) Upstream to establish a modern legal and regulatory framework for the petroleum sector and its regulation, enabling China to attract domestic and foreign investment to develop the hydrocarbon reserves. (b) Downstream to state the objectives for development of the gas industry and for competition in the transmission, distribution, and sales of gas; which parts of the industry to be subject to continuing regulatory oversight; and the composition, authority, and activity of the agency responsible for the oversight. This would help create an environment of regulatory stability. The law then would establish the policy framework governing the gas industry. 4.3 Making a Start: Regulation of the Downstream Gas Industry A start to implementation of new-style regulation needs to be made. An obvious area is downstream gas regulation, focusing first on long-distance gas transmission and second on bringing national standards for rational regulation to urban gas distribution. Announcement of the West­East Pipeline Project in July 2000 highlighted, for potential investors, the prospect of oil and gas sector development but also the fact that there is presently no specific downstream gas regulation. The gas industry requires a regulatory framework and its absence hinders investment and development in a sector, important parts of which have just been opened up to foreign enterprise. Considerable preparatory work for modern regulation of downstream gas is now being undertaken by the World Bank, in close consultation with Chinese counterparts. This "Study on the Implementation of the Regulatory Framework for China's Downstream Gas Sector" draws on the Joint Report and relates to such areas as the responsibilities of the regulator, regulatory principles, regulatory techniques, and arrangements for the transition period. Terms of reference (TOR) are under discussion for a second study that would encompass regulatory organization, procedures, and the drafting of a gas law. This work sets the stage for early establishment of those components of the interim regulatory organization that would be concerned with downstream gas. Consideration should be given to establishing the interim downstream gas regulatory organization as early as 2001. Such a "demonstration project" in modern regulation would clearly signal the government's intention to follow up on the Joint Report. It could properly be linked in part with the West­East project. Operationally it would provide a very specific invterface for the further work being undertaken by the World Bank and the China's Oil and Gas Sector: Policy, Structure and Regulation: Chapter 4 Page 43 Chinese Working Group. Also, it should be designed so as not to fragment sector regulation, but rather to pave the way for the creation of the comprehensive downstream oil and gas regulatory organization. 4.4 Implementation and Road Map The following "road map" (Table 4.1) serves as a guide and summary of key actions that should be taken. China's Oil and Gas Sector: Policy, Structure and Regulation: Chapter 4 Page 44 Table 4.1: An Illustrative Five-Year Road Map: Policy, Structure, Regulation, and Legislation Year Policy Structure Regulation Legislation 2000: Policy statement: Oil Study development of preparatory Review fiscal, licensing, detailed TOR for further year Restructure sector. PSCs, extension of license. research on structural and regulatory change Modernize regulation. Study taxation and pricing, (continuing process). of oil products. Authorize Director of the Policy directive: Study impact of removing Reform Bureau for remaining refinery regulatory structure Regulatory processes allocations of crude oil and implementation. to be consolidated in "one prices for crude oil and window" approach. retail prices for oil products. Create regulatory "road map" of existing Study the phaseout of processes. import quotas and licensing system for crude oil and Create interim regulatory products. organization, decisions on: locus, relationships; Legal staff of Gas authority; structure; interim regulatory Study phaseout of staffing; training: Identify organization works in- and out-Plan pricing. and empower "chief on comprehensive interim regulator" and a understanding of all Oil and Gas "core team?" current legal Study pipeline open-access instruments for and rate-making. Study how to monitor and regulation. report on structure and regulatory change and Prepares inventory market development. and analysis of current petroleum legislation and regulation. China's Oil and Gas Sector: Policy, Structure and Regulation: Chapter 4 Page 45 Year Policy Structure Regulation Legislation 2001: Policy decisions issued: Oil Regulatory decisions on pipeline Check whether can use transition Chinese E&D companies utilize rates and access to enable and existing legal instruments starts · Remove crude oil their right to explore both support oil and gas marketing by or need changes; initiate allocations and import onshore and offshore. PSC partners (to become if necessary. restrictions. effective 2002­03). Introduce crude oil and oil Check whether need · Phase out and unify product import quotas for legislative changes; in- and out-Plan prices for nonstate companies. Remove regulatory and policy initiate if necessary. gas. functions from SOEs, constitute Set up a scheme to gradually regulatory functions separately Legal staff tracks Policy directive: remove crude oil and product for transfer to interim then final legislative implications. Targets for PSC blocks to be import quotas and licensing regulatory organization, return licensed. system (completed by 2005). policy function to GOC. Legal staff tracks legal drafting that will be Allow Chinese companies and Initiate monitoring and reporting needed. JVs to invest and operate in on structure and regulatory wholesale oil products markets. changes and market behavior (continuing). Introduce maximum retail prices for gasoline and diesel. Start study and decision making about regulatory policy, Gas involving use of working groups Phase out in-Plan gas allocations (complete early 2002) to extent possible. Start study and decision making Extend the system of more on regulatory techniques market-oriented prices to all new pursuant to policy decisions gas projects, and promote (complete late 2002). market planning and development based on the competitiveness of gas vis-à-vis other fuels. Chinese and PSC companies to sell gas directly to consumers. Oil and Gas Increase the pool of exploration blocks available for licensing through a more aggressive land licensing policy: allow the Chinese companies to compete in the upstream industry without any geographical limitation, and promote transfer of exploration blocks to companies with different exploration ideas · To increase the number of exploration license areas available for bidding and award of PSCs and to offer prospective exploration land. · That the terms for extension of exploration licenses be strictly enforced and the cost of holding licenses be increased. · That all new and relinquished exploration blocks be China's Oil and Gas Sector: Policy, Structure and Regulation: Chapter 4 Page 46 available for PSCs, initially through annual competitive rounds. China's Oil and Gas Sector: Policy, Structure and Regulation: Chapter 4 Page 47 Year Policy Structure Regulation Legislation 2002: No new policy statements Oil Legal staff tracks legal second or decisions required. Any remaining approval of Complete study and decision drafting that will be transi- crude oil refinery gate prices making on regulatory policy. needed; initiates tion Policy level receives eliminated. drafting as policy and year periodic briefings on Complete study and decision technical work is progress in industry Chinese and PSC companies making on regulatory completed and structure and regulatory sell profit oil directly to techniques (economic; land approved. reform. customers. and fiscal; technical; and health, safety, and Formulation of Pilot projects for products environment). technical regulations liberalization begin. proceeds even while Interim regulatory policy-level Oil and Gas organization continues consideration is being Allow foreign investors to oversight of transition to given to its legal own a majority interest in competitive products setting, for example, a pipelines. markets, progress of other "petroleum law" for structural and regulatory China. Introduce a regulated open- change. access pipeline regime. 2003: Issuance of revised and Oil Consolidation year: no new Development of third final policies on oil and Remove restrictions on initiatives regulations freeing up transi- gas pricing. foreign majority participation oil and gas commodity tion in retail gasoline and diesel, Interim regulatory markets. year and allow foreign companies organization has achieved to own majority interest in high degree of cooperation Legal staff continues refineries. and coordination with contact and completes work agencies, interim regulation on regulations that system is functioning embody and give effectively in support of effect to decisions on changes in industry structure, regulatory techniques. successfully overseeing competitive products market transition, providing periodic reports and assessments to policy level. Size and capability of interim regulatory organization staff continuously reviewed and adjusted, training continues, including of staff in contact agencies. China's Oil and Gas Sector: Policy, Structure and Regulation: Chapter 4 Page 48 Year Policy Structure Regulation Legislation 2004: Policy decision, following Interim regulatory Completion of all formal formal review, on whether organization completes regulatory drafting. review to complete regulatory formal review of regulatory year reform, set up reform program. Positive State Council commissions. decision authorizes Responsibility center(s) any necessary work on receives review and forwards new laws. to State Council for discussion and decision. 2005: No further policy Oil All regulatory functions and Legal drafting is comple- decisions required. Complete removal of crude activity concentrated under continued and tion oil import quotas and interim regulatory completed. year National People's licensing system. organization, all staff now Congress approval. co-located (first months). The new legal Reduce product import structure is enacted by New lawmaking required. tariffs, and eliminate import- Period of intensive staff the National People's export quotas and product training and cooperation in Congress and other licensing system and all new quarters. lawmaking authorities economic controls on as appropriate. investment in any oil and gas Up- and downstream business sectors--upstream, regulatory commissions midstream, and downstream. appointed, organized, and absorb functions. Accelerate corporatization of municipal enterprises in the wholesale market, and integrate with a program of share listings (by 2005). Introduce bidding for new exploration blocks by Chinese companies. Annexes 1. List of Experts that Participated in the Work Group Meetings 2. A Comparative Analysis of the Upstream Fiscal Terms for China 3. Market Opening and Security of Oil Supply 4. "Qualification" or "Certification" of Participants in Oil and Gas Operations 5. A Comprehensive Listing of Proposed Regulatory Activity 6. Environmental Regulation 7. International Cases of Structural and Regulatory Reform Annex 1: List of Experts that Participated in the Work Group Meetings An Fengquan Planning Institute, SINOPEC, Senior Engineer Cai Jingyong Investment Banking Department, CICC, General Manager Che Changbo Prospecting Department Administration of State Land Resources, Division Chief Chen Fanghong Planning Department, CNPC, Deputy Division Chief Chen Zhanjie Laws and Regulations Department, Administration of State Land Resources, Senior Engineer Fang Fenglei CICC, Deputy Executive Officer Feng Fei Industry Department Development Research Center, State Council, Deputy Department Chief Gan Zangchun Laws and Regulations, Department Administration, State Land Resources, Deputy Chief He Jia Laws and Regulations, SAPCI, Deputy Division Chief He Junxiong International and National Taxation Department State Taxation Administration, Deputy Division Chief Huang Taihe SCRES, Deputy Director Hu Bingjun Financial Department, CNPC He Chang Offshore Region Management Department, CNOOC, Engineer Li Jian Comprehensive Division, Taxation System and Rules Department, MOF Li Jiaqiang Research Institute of Economic Technology, SINOPEC, Senior Engineer Ling Jiang Laws and Regulations Department, SEPA, Division Chief Li Runsheng Laws and Regulations Department, SAPCI, Deputy Chief Liu Bin Reserve Department, Administration of Land Resources, Deputy Division Chief Liu Jingsheng Investment Banking, CICC, Deputy General Manager Liu Xianfa Laws and Regulations Department, SAPCI, Deputy Division Chief Liu Xiaowei Investment Baking, CICC, Deputy General Manager Ma Shenyuan Planning Department, SAPCI, Deputy Division Chief Man Rui Development Research Department, CNPC, Deputy Division Chief Mu Guangfeng Supervision and Management Department, SEPA, Deputy Department Chief Nie Lei Development Strategic Research Team, SINOPEC, Economist Niu Yubin Price Department, SDPC Peng Jianqin Information Research Center, CNPC, Professor Shi Xingchun Economic and Information Research Center, CNPC, Deputy Director Su Weixing Laws and Regulations, Administration of Land Resources, Division Chief Tang Zhengguo Reserve Department Administration of Land Resources, Sector Chief Wang Baocheng Planning Department, SDPC Wang Zhonghua Planning Department, SDPC Xiang Ze Price and Taxation Division, Financial Department, CNPC, Division Chief Xu Dian International Price Taxation Department, State Taxation Administration, Division Chief Xiu Tao Taxation System and Rules Department, MOF, Deputy Division Chief Yang Dan Investment Banking, CICC, Manager Yang Huijie Financial Department PetroChina Ltd. Yang Jiwu Environment Department, CNOOC Yang Xiaoyi Safety and Environment Protection Office, CNOOC, Engineer Yang Rue Investment Banking, CICC, Assistant Manager Rao Yishan Quality, Safety and Environment Department, CNPC Senior Engineer Yuan Qingdan Policy Research, Office, SEPA, Sector Chief Zhan Kun Safety and Environment Bureau, SINOPEC, Deputy Director Zhang Xuzhi Development Strategic Research Team, SINOPEC, Bureau Chief Zhang Yuqing Economic Projection Department, SDPC, Deputy Division Chief Zhao Xiaohui Consulting Firm, SINOPEC Zheng Biying Safety and Environment Protection Office, CNOOC, Division Chief Zhou Jiangang Economic and Research Center, CNPC Zhu Yu Planning Institute, SINOPEC, President Annex 2: A Comparative Analysis of the Upstream Fiscal Terms for China Introduction 1. This report was prepared by Dr. Pedro van Meurs at the request of the World Bank to provide an economic rating of the Chinese upstream petroleum fiscal terms and propose some modifications to these terms as a result of the partial listing of CNOOC and CNPC.1 Economic Framework 2. The comparative analysis was based on offshore costs and production data, regardless of whether terms applied to the onshore or the offshore. This was to provide for a common reference and framework on a worldwide basis. The analysis was for oil only and compared 284 upstream petroleum terms. Other factors, such as geological, political and regulatory differences between the countries and jurisdictions were not included. Costs and Production: Offshore Fields Water Depth 3. Fields were assumed to be in less than 200 meters of water. Field Sizes 4. Three oil field sizes were used for the economic analysis, as follows: · 300 million barrels (bbl) · 150 million barrels · 75 million barrels Number of Producing Wells 5. Crucial to the economics of the project was the number of wells that would be required for oil production. It was assumed that the oil fields would have the following number of wells: · 300 million barrels: 10 wells · 150 million barrels: 12 wells · 75 million barrels: 14 wells 6. The number of wells increases as the fields become smaller. This is normally not the case. Normally larger fields have a large number of wells. However, by inverting the range, a wider diversity of possible production and cost structures can be evaluated. This means that the scenarios range from rather poor small fields to rather prolific large fields and provide a good comparison of economic results and fiscal systems. 1The analyses was done before the partial listing of Sinopec. Maximum Production Levels and Field Life 7. It was assumed that the fields would be produced over a short life, with relatively high maximum production levels. Today, this is the most common way of producing oil. The following table shows the maximum production levels and field lives that are used: Maximum Field Field size production life (barrels of oil) (bopd) (years) 300 million 100,000 15 150 million 55,000 12 75 million 35,000 10 Offshore Economic Framework Costs 8. The cost assumptions used in the analysis are shown in Box 1: Box 1: Cost Assumptions Geophysical costs. Geophysical costs were estimated at $5 million during the first year of the cash flow. Exploration well costs. It was assumed that the exploration well would cost $25 million on the basis of a floating drilling platform in shallow waters. Delineation well costs. It was assumed that one delineation well would be required for the small fields, two wells would be required for the medium-sized fields, and three wells for the large fields. The costs were assumed to be $20 million per well. Platforms and facilities. The platform and facilities costs were estimated in a general manner because it was not possible to consider specific designs or layouts of the field. The total platform and facilities costs for the six fields in less than 200 meters of water were estimated as follows: · 300 million barrels: $440 million · 150 million barrels: $320 million · 75 million barrels: $200 million Investments were typically assumed to take place over a two-year period. Platform wells. Platform wells were assumed to cost $10 million. Operating costs. The fixed operating costs were assumed to be $8 million per year for the small fields, $11 million per year for the medium-sized fields, and $14 million per year for the large fields. The variable costs were assumed to be the following: · For the small fields: $4 per barrel · For the medium-sized fields: $3.50 per barrel · For the large fields: $3 per barrel Overall Cost Analysis 9. The total costs were summarized on a per-barrel basis in the following table to make them comparable to other international data. Capital Operating Total costs costs per costs per Field size per bbl bbl bbl (barrels of oil) ($/bbl) ($/bbl) ($/bbl) 300 million 2.11 3.70 5.81 150 million 3.42 4.38 7.80 75 million 5.24 5.07 10.31 bbl = barrel. Prices 10. The future oil price is subject to considerable uncertainty. The price was assumed to be $21 per barrel. 11. The oil prices apply to prices at the delivery point of the production platform into a tanker. Escalation 12. All investment and operating costs, as well as oil prices, were escalated at 3 percent per year. Timing 13. For all cases it was assumed that the exploration phase would take two years and would include a seismic program and the first exploration well. Subsequently, a two-year delineation and appraisal phase followed with the drilling of delineation wells and follow-up seismic surveys. Then, a two-year construction phase would start, with development drilling and production to start in the second year of this period (the sixth year of the cash flow). Finally, additional drilling and increases in production follow until maximum production has been reached. Financing 14. All fields were analyzed before financing because companies would typically analyze exploration projects this way. After a commercial discovery has been declared, however, financing of development would be possible. Total Cash Flows 15. In summary, the economic results of the various cases in constant U.S. dollars are the following: Cases Gross Capital Operating Divisible Rate of NPV at Field size revenues costs costs income return 10% (barrels) ($ million) ($ million) ($ million) ($ million) (%) ($ million) 300 million 6,300 633 1,110 4,557 50.2 1,499 150 million 3,150 513 657 1,980 42.0 694 75 million 1,575 393 380 802 30.8 266 Project 614 122 126 367 27.3 111 NPV = net present value. 16. The table shows a wide variation between the fields in terms of gross revenues received and capital and operating costs. The "divisible income" is the difference between the revenues and the costs. It is called divisible income because this is the income that will be divided between the government and the company. 17. "Project" refers to the economics of the exploration project, taking into account geological risk. The geological risk was estimated as follows: · Probability of a dry hole: 80 percent · Probability of a small discovery: 7 percent · Probability of an average discovery: 10 percent · Probability of a large discovery: 3 percent 18. Based on the revenues, costs, and risks assumed above, the prospects for the Project are rather profitable before any government take of a 27 percent rate of return. Stand-Alone and Incremental Analyses 19. Two types of analysis can be carried out: · Stand-alone analysis · Incremental analysis 20. "Stand-alone" analysis means the analysis of a project on the assumption that it is the first and only project that an investor is carrying out in a particular country and in a particular contract area. This has important implications for the calculation of corporate income taxes and other fiscal instruments. 21. "Incremental analysis" means the analysis of a project on the assumption that there is already an "ongoing" operation. For instance, an oil field is already producing and there is already taxable income. In this case, the investment in a new exploration well results directly in a tax deduction or results in the immediate recovery in the form of additional cost oil. In other words the "net cost" of the investment is less than the total costs. 22. The rating is based on stand-alone analysis. Yardsticks for Profitability and Risk Analysis 23. For simplicity a single yardstick for comparison was used--the rate of return for the individual cases and risked rate of return for the project. 24. Rate of Return (ROR). This is the cash flow rate of return. The rate of return is on total capital. The rate of return indicates the profitability of the investment. 25. Risked Rate of Return. The project is the rate of return of the weighted average cash flow. Economic Rating Fiscal Systems Used 26. In total, 284 fiscal systems around the world were used for comparison with the Chinese terms. Three sets of Chinese terms were used: · Offshore terms · Onshore regular terms · Onshore frontier terms 27. In addition, an alternative for the offshore terms was also rated. In total, therefore, the rating in table 1 includes 285 fiscal systems. 28. Onshore terms for the continental United States and Canada were not included in the analysis, because these terms apply to rather different economic situations of usually very low cost operations. However, the offshore U.S. and Canadian terms were included. Chinese Fiscal Terms 29. The Chinese terms applied in the analysis are summarized in this section. China Offshore Terms Bonuses Signature bonus: $0.25 million; $0.50 million upon selection of development area. Rentals and Fees None (paid by CNOOC). VAT and Royalties 5 percent VAT. Royalties: Sliding scale: 0 percent up to 1 million t/yr, 4 percent up to 1.5 million t/yr, 6 percent up to 2 million t/yr, 8 percent up to 3 million t/yr, 10 percent up to 4 million t/yr, and 12.5 percent over 4 million t/yr. Cost Oil Cost oil limit 62.5 percent of gross production. Royalty under cost oil limit is deducted first. Operational costs next, exploration and development costs last. Deemed interest of 9 percent for development costs. Income Tax Income tax 30 percent plus 3 percent local tax for a total rate of 33 percent. Exploration costs expensed. Development and facilities depreciated over 6 years straight line. Profit Oil Eight-step sliding scale: government share of profit oil from 8 percent to 75 percent (assumed). Participation CNOOC has option to participate for 51 percent in each commercial discovery. Profit Share None. Other Tax consolidation (not applicable for stand-alone analyses). Legal Framework of Fiscal Terms: Negotiability Profit oil split negotiable. Stability All terms fixed in contract, except corporate income tax. China Onshore--Regular terms Bonuses Signature bonus of $1 million, not recoverable. Rentals and Fees None. VAT 5 percent VAT. Royalties Sliding scale: 0 percent up to 0.5 million t/yr, 2 percent for 0.5 to 1.0 million t/yr, 4 percent for 1.0 to 1.5 million t/yr, 6 percent for 1.5 to 2 million t/yr, 8 percent for 2 to 3 million t/yr, 10 percent for 3 to 4 million t/yr, and 12.5 percent over 4 million t/yr. Income Tax Income tax 30 percent plus 3 percent local tax for a total rate of 33 percent. Exploration costs expensed. Development and facilities depreciated over 6 years straight line. Cost Oil Cost oil limit 60 percent of gross production.2 Exploration costs recovered first. Operational costs next and development costs last. Deemed interest of 9 percent. Royalty deducted separately from the remaining 40 percent. Profit Oil Eight-step sliding scale: Government share of profit oil from 5 percent to 60 percent (assumed). Participation Petrochina has the option to participate for 51 percent in each commercial discovery. Profit share None. Legal Framework of Fiscal Terms: Negotiability Profit oil split negotiable. Stability All terms fixed in contract, except corporate income tax. 2Assumption used for calculations. Contracts without maximum cost oil limit may exist. China Onshore Terms for Qinhai Province, Tibet and Xinjiang Uigur Autonomous Regions Assumed Fiscal Terms: Onshore Second Round, February 1994, with 1995 Royalty Incentives; See WPA95-I, p. 522; PW96, p. 106, VMA info. Bonuses Signature bonus of $1 million, not recoverable. VAT 5 percent VAT. Rentals and Fees None. Royalties Sliding scale: 0 percent up to 1 million t/yr, 4 percent for 1 to 1.5 million t/yr, 6 percent for 1.5 to 2 million t/yr, 8 percent for 2 to 3 million t/yr, 10 percent for 3 to 4 million t/yr, and 12.5 percent over 4 million t/yr. Income Tax Income tax 30 percent plus 3 percent local tax for a total rate of 33 percent. Exploration costs expensed. Development and facilities depreciated over 6 years straight line. Cost Oil Cost oil limit 60 percent of gross production. Exploration costs recovered first. Operational costs next and development costs last. Deemed interest of 9 percent. Royalty deducted separately from the remaining 40 percent. Profit Oil Eight-step sliding scale: Government share of profit oil from 5 percent to 60 percent (assumed). Participation State option to participate for 51 percent in each commercial discovery. Profit share None. Legal Framework of Fiscal Terms: Negotiability Profit oil split negotiable. Stability All terms fixed in contract, except corporate income tax. 30. The profit oil sliding scales for offshore and onshore are biddable items. The assumed scale is not based on any specific contract: Offshore Onshore Profit splits (bopd) (%) (%) Up to 10,000 8 5 10,000­20,000 10 8 20,000­40,000 12 12 40,000­60,000 20 25 60,000­100,000 27 30 100,000­150,000 40 40 150,000­200,000 65 50 Over 200,000 75 60 31. The rating of the Chinese system, shown in the next section, depends to a considerable decree on the profit oil splits that are being assumed. The scales assumed in this comparative analysis are relatively attractive and do not necessarily reflect the average terms that were concluded so far. Results of the Worldwide Rating 32. Table 1 in the attachment provide for the worldwide rating of the Chinese offshore terms, onshore regular terms, and onshore frontier terms. 33. The worldwide rating of the offshore fiscal terms is shown in the following table: 75 million bbl 150 million bbl 300 million bbl Project Ranking: 111--Onshore 112--Onshore 115--Offshore 141--Onshore fontier front front 122--Onshore 115--Offshore 116--Onshore 146--Offshore regular front 123--Offshore 116--Regular 123--Regular 149--Regular It can be seen how the Offshore field rates slightly below the onshore fields for the small fields and slightly above the onshore fields for the large field. This is because of the profit oil sliding scale. 34. The fields rate approximately the same on a worldwide basis regardless of the field size. This is because of the generally neutral nature of the fiscal terms. The overall level among 285 fiscal systems is relatively favorable for the three "no-risk" field sizes. In all cases, the fiscal systems rate somewhat better than the average of 142. 35. The Project, however, rates around the worldwide average. 36. The relatively poorer rating of the Project is entirely because of the 51 percent carried interest. This carried interest harms the exploration economics considerably because 51 percent of the cash flow is earned by CNOOC/Petrochina after a discovery. 37. This means that in general, the overall structure of the Chinese model contracts permit, in principle, achievement of fiscal terms that are average on a worldwide basis, depending on the sliding scale that is offered during the bids. However, the structure also is inherently unfavorable from an exploration point of view. Possible New Contract Listing of State-Owned Enterprises 38. The successful initial public offering (IPO) for PetroChina listing 10 percent of CNPC's shares in core domestic assets and the prospects for listings of CNOOC and Sinopec create no specific problems with respect to the existing production sharing contracts (PSC). 39. From the prospectuses of the three major Chinese companies it is understood that IOCs can only undertake offshore E&D activities in China through a PSC with these companies. In the reorganization in preparation for the listing of public shares, the three major Chinese companies' commercial rights in all existing and future PSCs were transferred to the Listed companies. The Listed companies, however, do not have the capacity to enter into PSCs directly with foreign enterprises under existing Chinese law. Accordingly, the parent companies will continue to enter into PSCs, but after signing a contract, they will immediately assign to the Listed companies all their commercial and operational rights. 40. The parent companies will retain all its administrative functions--including organization of international bidding, award, and assignment of PSCs--receive any signature bonuses, approve any extensions of the period for the completion of appraisal work, and submit plans and reports to the government. The Listed companies, however, will receive the rights, benefits, and obligations regarding the implementation of PSCs. It is understood that the Listed companies carry the cost, receive the profit oil and gas, and retain the right to take up to a 51 percent participating interest in the development of any oil and gas field after the PSC partner has undertaken the exploration costs. The public share offering of PetroChina included a similar reorganization of CNPC with regard to PSCs. 41. As part of the listing, the government will receive full value for the carried interest of CNOOC and the profit oil. 42. As an example, Canada went through a similar process with the privatization of PetroCanada. PetroCanada also owned carried interests in the frontier areas, such as in the Hibernia field as a result of previous legislation. With the privatization, this carried interest was maintained, and it flowed to the private investor. In Canada, however, PetroCanada was treated as any other oil company once the privatization process had started. 43. In China, the issuance of new blocks raises an issue, since the prospectus indicates that the listed CNOOC will continue to receive the carried interest on new blocks and profit oil. A severe conflict of interest could be the result of the practice of giving partially listed companies a carried interest and profit oil from new blocks that are being negotiated by the government-owned parent company. Possible New PSC 44. The carried interest option is widely used in many countries in the first phase of petroleum development to transfer technology and management skills to national or state companies. However, it poses a special issue because it harms the exploration economics considerably, since the investor carries the exploration costs and only receives 49 percent of the revenues. The following example shows how much profit oil shares can be increased if the carried interest option is substituted by a profit oil share in future bidding rounds. It would considerably enhance the interest in exploration because the removal of the carried interest improves the exploration economics. 45. The following table shows the new profit oil splits that were used in calculating an illustrative example of changed terms: Profit splits (bopd) Offshore-old Offshore-new (%) (%) Up to 10,000 8 30 10,000­20,000 10 35 20,000­40,000 12 40 40,000­60,000 20 45 60,000­100,000 27 50 100,000­150,000 40 55 150,000­200,000 65 75 Over 200,000 75 85 46. These new splits, together with the removal of the carried interest, create a more progressive fiscal system that is much more attractive to explorers, as can be seen from the resulting new rating. The new rating is as follows: 75 million bbl 150 million bbl 300 million bbl Project Ranking: 107--New PSC 112--Onshore 115--Offshore 108--New PSC frontier 111--Onshore 115--Offshore 116--Onshore 141--Onshore frontier frontier frontier 122--Onshore 116--Onshore 123--Onshore 146--Offshore regular regular regular 123--Offshore 119--New PSC 133--New PSC 149--Onshoreregular 47. It can be seen how the new PSC would be more attractive for the small fields, but tougher for the larger fields because the fiscal system is now more progressive. At the same time, the Project now rates considerably better than before, making the exploration much more attractive. Conclusion 48. The comparative analyses of China's offshore terms for petroleum show that their attractiveness is about average compared with a worldwide rating of around 280 fiscal systems. The government has recently taken initiatives to improve the attractiveness of the fiscal terms for investors. Local procurement of goods and services, for instance, will allow additional income tax deductions to foreign investors. This will mainly affect the development of oil and gas onshore. The government is also considering further changes to improve the fiscal terms. 49. However, more fundamental changes in the fiscal and contractual system for petroleum E&D may be required to ensure its competitiveness. A question is whether the PSC structure is sustainable in the long term, in particular if larger shares of the companies are being offered to private shareholders. The transfer of the state's right to profit oil and of the carried interest option for future contracts to a partly private company will result in part of the economic rent being transferred to private parties. 50. Further work in the area of fiscal systems and their legal and contractual framework would be required. This work should include options for increasing the competitiveness of the Chinese fiscal system for petroleum, analysis of options for petroleum contracts with foreign investors as a supplement to PSCs, and how to improve the transparency and timing of the bid award process. 16 Table 1: Worldwide Rating of Fiscal Regimes 75 million barrels 150 million barrels 300 million barrels Project Rank Name ROR Rank Name ROR Rank Name ROR Rank Name ROR 1 No Gov. Take 0.347 1 No Gov. Take 0.463 1 No Gov. Take 0.547 1 No Gov. Take 0.312 Spreadsheet Spreadsheet Spreadsheet Spreadsheet 2 Svalbard 0.301 2 Svalbard 0.416 2 Svalbard 0.501 2 Svalbard 0.28 3 Ireland-off-frt 0.292 3 Arg-T del Fuego 0.405 3 Arg-T del Fuego 0.491 3 Arg-T del Fuego 0.272 4 Ireland-off-dp 0.292 4 Palau 0.403 4 Palau 0.489 4 Palau 0.272 5 Ireland-off-sh 0.291 5 Ireland-off-frt 0.397 5 Ireland-off-frt 0.479 5 Ireland-off-frt 0.264 6 Lebanon-on 0.291 6 Ireland-off-dp 0.397 6 Ireland-off-dp 0.479 6 Ireland-off-dp 0.264 7 Arg-T del Fuego 0.291 7 Ireland-off-sh 0.397 7 Ireland-off-sh 0.479 7 Ireland-off-sh 0.264 8 Palau 0.289 8 Lebanon-on 0.388 8 Lebanon-on 0.465 8 Lebanon-on 0.26 9 St Pierre&Miq 0.274 9 St Pierre&Miq 0.378 9 Bahamas 0.46 9 Bahamas 0.252 10 Bahamas 0.264 10 Bahamas 0.376 10 St Pierre&Miq 0.459 10 St Pierre&Miq 0.247 11 UK-off 0.264 11 Kaz-OOC 0.367 11 UK-off 0.447 11 UK-off 0.241 12 Kaz-OOC 0.261 12 UK-off 0.366 12 Kaz-OOC 0.435 12 Kaz-OOC 0.241 13 Nicaragua 0.258 13 Nicaragua 0.356 13 Port-off-dp 0.434 13 Nicaragua 0.234 14 Port-off-dp 0.255 14 Port-off-dp 0.356 14 Nicaragua 0.434 14 Port-off-dp 0.232 15 OCS-GOM>800m 0.254 15 Chad 0.354 15 Moldova 0.43 15 Mongolia 0.232 16 Chad 0.253 16 Mongolia 0.352 16 Chad 0.429 16 Moldova 0.229 17 Bioko-off-sh 0.251 17 Paraguay 0.348 17 Paraguay 0.429 17 Chad 0.228 18 Israel-off 0.249 18 Israel-off 0.348 18 Israel-off 0.427 18 Cyprus 0.226 19 Israel-on 0.249 19 Israel-on 0.348 19 Israel-on 0.427 19 Sweden 0.226 20 Sweden 0.247 20 OCS-GOM>800m 0.345 20 Cyprus 0.425 20 Paraguay 0.225 21 OCS-GOM<800m 0.247 21 Sweden 0.344 21 Sweden 0.424 21 Puerto Rico 0.225 22 Paraguay 0.247 22 Puerto Rico 0.343 22 Puerto Rico 0.423 22 Uruguay 0.224 23 Puerto Rico 0.245 23 Cyprus 0.342 23 Uruguay 0.421 23 Israel-off 0.223 24 Mongolia 0.245 24 Moldova 0.341 24 Mongolia 0.419 24 Israel-on 0.223 25 Denm-gen-4thR 0.243 25 Uruguay 0.339 25 UK-N Ireland 0.419 25 UK-N Ireland 0.223 26 Greece 0.241 26 UK-N Ireland 0.338 26 Falkland Isl 0.416 26 Falkland Isl 0.221 27 Cyprus 0.238 27 Bioko-off-sh 0.337 27 OCS-GOM>800m 0.415 27 Austria-new 0.218 28 Uruguay 0.237 28 Greece 0.337 28 Greenland 0.414 28 Germany-off 0.217 29 UK-N Ireland 0.236 29 Falkland Isl 0.336 29 Croatia 0.413 29 Greece 0.216 30 Falkland Isl 0.234 30 OCS-GOM<800m 0.335 30 Austria-new 0.409 30 Italy-off 0.213 Contd.. 17 75 million barrels 150 million barrels 300 million barrels Project Rank Name ROR Rank Name ROR Rank Name ROR Rank Name ROR 31 Greenland 0.234 31 Greenland 0.333 31 Greece 0.409 31 Port-on 0.213 32 Port-off-sh 0.234 32 Croatia 0.33 32 OCS-GOM<800m 0.407 32 Port-off-sh 0.212 33 Port-on 0.233 33 Austria-new 0.328 33 Germany-off 0.407 33 Bioko-off-sh 0.212 34 Pak-on-Zone1 0.231 34 Port-on 0.328 34 Italy-off 0.406 34 Argentina-gen 0.212 35 Qatar-restated 0.231 35 Port-off-sh 0.328 35 Port-on 0.405 35 Greenland 0.211 36 Austria-new 0.23 36 Kaz-Oryx 0.326 36 Port-off-sh 0.403 36 Poland-on-gen 0.211 37 Kaz-Oryx 0.23 37 Germany-off 0.326 37 Poland-on-gen 0.403 37 Pak-on-Zone1 0.21 38 Madagascar 0.229 38 Italy-off 0.325 38 France 0.403 38 Jamaica 0.209 39 Moldova 0.227 39 Pak-on-Zone1 0.324 39 Argentina-gen 0.403 39 Kaz-Oryx 0.208 40 Guyana-off 0.227 40 Poland-on-gen 0.323 40 Belize 0.402 40 OCS- 0.208 GOM>800m 41 Nova Scotia-off 0.226 41 Belize 0.321 41 Pak-on-Zone1 0.402 41 France 0.208 42 Italy-off 0.226 42 France 0.321 42 Jamaica 0.401 42 Belize 0.208 43 Germany-off 0.226 43 Madagascar 0.32 43 Fiji 0.394 43 Madagascar 0.207 44 Poland-on-gen 0.225 44 Argentina-gen 0.319 44 Kaz-Oryx 0.393 44 Fiji 0.207 45 Peru-off-Z-29 0.224 45 Jamaica 0.319 45 Peru-off-Z-29 0.392 45 Pak-off-dp 0.205 46 Belize 0.223 46 Guyana-off 0.317 46 Hungary 0.391 46 Peru-off-Z-29 0.205 47 Pak-off-dp 0.222 47 Pak-off-dp 0.317 47 Pak-on-Zone2 0.39 47 Hungary 0.203 48 Pak-on-Zone2 0.222 48 Peru-off-Z-29 0.316 48 Switzerland 0.39 48 Dominican Rep 0.203 49 France 0.22 49 Nova Scotia-off 0.314 49 Madagascar 0.39 49 Guyana-off 0.203 50 Newf-off-gen 0.22 50 Pak-on-Zone2 0.314 50 Bioko-off-sh 0.389 50 OCS- 0.202 GOM<800m 51 Jamaica 0.219 51 Dominican Rep 0.312 51 New Zealand 0.389 51 Costa Rica 0.201 52 Eritrea-min 0.219 52 Fiji 0.312 52 Costa Rica 0.389 52 Switzerland 0.201 53 Argentina-gen 0.218 53 Hungary 0.312 53 Mauritius 0.388 53 Mauritius 0.201 54 Croatia 0.218 54 Eritrea-min 0.31 54 Pak-off-dp 0.387 54 Nova Scotia-off 0.201 55 Pak-off-sh 0.217 55 Pak-off-sh 0.309 55 Eritrea-min 0.387 55 Eritrea-min 0.2 56 South Africa 0.217 56 Barbados 0.309 56 Nova Scotia-off 0.386 56 Barbados 0.2 57 Barbados 0.216 57 Switzerland 0.309 57 Barbados 0.386 57 Pak-on-Zone2 0.199 58 Austr-off-gen 0.216 58 China-Taiwan 0.307 58 Dominican Rep 0.385 58 China-Taiwan 0.198 59 Timor Gap-ZOCB 0.216 59 OCS-GOM<400m 0.307 59 Niger 0.385 59 Pak-off-sh 0.198 60 OCS-GOM<400m 0.215 60 Mauritius 0.305 60 OCS-GOM<400m 0.382 60 Schleswig Holst 0.196 61 Dominican Rep 0.215 61 Niger 0.304 61 China-Taiwan 0.381 61 Haiti 0.196 62 Hungary 0.214 62 Costa Rica 0.303 62 Guyana-off 0.38 62 C Afr Rep 0.193 63 Senegal 0.214 63 Pak-on-Zone3 0.303 63 Pak-on-Zone3 0.379 63 Czech Rep 0.192 64 Fiji 0.213 64 Senegal 0.302 64 Haiti 0.378 64 Lower Saxony 0.192 18 75 million barrels 150 million barrels 300 million barrels Project Rank Name ROR Rank Name ROR Rank Name ROR Rank Name ROR 65 Pak-on-Zone3 0.212 65 C Afr Rep 0.3 65 C Afr Rep 0.377 65 Niger 0.192 66 New Zealand 0.21 66 Qatar-restated 0.3 66 Schleswig Holst 0.375 66 Maldives 0.191 67 Canada-NWTerr 0.209 67 Haiti 0.3 67 Pak-off-sh 0.375 67 Philipp-off-dp 0.19 68 China-Taiwan 0.209 68 Denm-gen-4thR 0.298 68 Senegal 0.374 68 Ecuador-min 0.19 69 Philipp-off-dp 0.209 69 South Africa 0.297 69 Czech Rep 0.374 69 Pak-on-Zone3 0.188 70 Switzerland 0.207 70 Philipp-off-dp 0.297 70 Maldives 0.371 70 Senegal 0.188 71 Zambia 0.207 71 Schleswig Holst 0.296 71 Philipp-off-dp 0.37 71 Croatia 0.188 72 C Afr Rep 0.207 72 Tanz-Rukwa 0.295 72 Lower Saxony 0.369 72 Qatar-restated 0.185 73 Nig-off>1000m 0.206 73 Nig-off>1000m 0.294 73 OCS-GOM<200m 0.368 73 Turkey 0.185 74 Mauritius 0.205 74 Austr-off-gen 0.294 74 Nig-off>1000m 0.368 74 Japan 0.185 75 Tanz-Rukwa 0.205 75 Timor Gap-ZOCB 0.294 75 Lithuania 0.366 75 Denm-gen-4thR 0.185 76 Tanz-mdl 0.205 76 Zambia 0.293 76 Zambia 0.364 76 Tanz-Rukwa 0.185 77 Newfoundland-on 0.204 77 Newf-off-gen 0.292 77 Viet-off-dp 0.362 77 Austr-off-gen 0.183 78 Tanz-Texaco 0.204 78 Ecuador-min 0.291 78 Japan 0.362 78 Timor Gap- 0.183 ZOCB 79 Uganda-mdl 0.204 79 Czech Rep 0.291 79 South Africa 0.361 79 OCS- 0.183 GOM<400m 80 Schleswig Holst 0.2 80 Maldives 0.29 80 Turkey 0.36 80 Nig-off>1000m 0.183 81 Costa Rica 0.2 81 Lower Saxony 0.29 81 Ecuador-min 0.36 81 New Zealand 0.182 82 Guat-97r-15 0.198 82 OCS-GOM<200m 0.289 82 Timor Gap-ZOCB 0.36 82 Zambia 0.181 83 Niger 0.198 83 Viet-off-dp 0.286 83 Austr-off-gen 0.36 83 Lithuania 0.181 84 Namibia 0.196 84 Tanz-mdl 0.286 84 Nig-off<1000m 0.356 84 Viet-off-dp 0.18 85 New S Wales 0.195 85 Turkey 0.285 85 Viet-off-sh 0.354 85 Philipp-off-sh 0.18 86 SaoTome&Princ 0.195 86 Newfoundland-on 0.285 86 Newfoundland-on 0.354 86 Newf-off-gen 0.18 87 Ecuador-min 0.195 87 Japan 0.284 87 Peru-on-mdl 0.352 87 Newfoundland-on 0.178 88 Lower Saxony 0.194 88 Nig-off<1000m 0.282 88 Newf-off-gen 0.352 88 Tanz-mdl 0.177 89 Nig-off<1000m 0.194 89 Lithuania 0.281 89 Mali 0.352 89 Peru-on-mdl 0.176 90 Viet-off-dp 0.194 90 Tunisia-frt 0.28 90 Tunisia-frt 0.352 90 Slovakia 0.175 91 Turkey 0.193 91 SaoTome&Princ 0.28 91 Philipp-off-sh 0.352 91 Viet-off-sh 0.175 92 Japan 0.193 92 Viet-off-sh 0.279 92 SaoTome&Princ 0.351 92 Nig-off<1000m 0.174 93 Maldives 0.192 93 Tanz-Texaco 0.279 93 Slovakia 0.35 93 Tunisia-frt 0.174 94 OCS-GOM<200m 0.192 94 Tunisia-gen 0.278 94 Ras Al-Khaimah 0.35 94 OCS- 0.173 GOM<200m 95 Kenya 0.192 95 Guat-97r-15 0.278 95 Tunisia-gen 0.349 95 Guat-97r-15 0.173 96 Haiti 0.192 96 Kenya 0.278 96 Tanz-Rukwa 0.347 96 Cote dIv-off-dp 0.173 97 Tunisia-frt 0.191 97 Canada-NWTerr 0.278 97 Sierra Leone 0.344 97 SaoTome&Princ 0.173 98 Tunisia-gen 0.191 98 Peru-on-mdl 0.277 98 Nig-off<800m 0.343 98 Tunisia-gen 0.172 19 75 million barrels 150 million barrels 300 million barrels Project Rank Name ROR Rank Name ROR Rank Name ROR Rank Name ROR 99 Czech Rep 0.191 99 Philipp-off-sh 0.276 99 Italy-on 0.342 99 South Africa 0.17 100 Peru-on-mdl 0.19 100 Mali 0.274 100 Korea-South 0.342 100 Kenya 0.169 101 Newf-Hibernia 0.189 101 Namibia 0.272 101 Peru-on-Camisea 0.339 101 Neth Antilles 0.169 102 India-psc-nocar 0.189 102 Cote dIv-off-dp 0.27 102 Denm-gen-4thR 0.338 102 Mali 0.169 103 Philipp-off-sh 0.188 103 Nig-off<800m 0.269 103 Togo 0.335 103 Bangladesh 0.168 104 Somalia 0.188 104 Togo 0.269 104 Qatar-restated 0.335 104 Sierra Leone 0.168 105 Togo 0.187 105 Malay-off-dp 0.269 105 Tanz-mdl 0.335 105 Tanz-Texaco 0.168 106 Viet-off-sh 0.187 106 Ras Al-Khaimah 0.268 106 Algeria-min 0.335 106 Italy-on 0.167 107 China-NewPSC 0.186 107 India-psc-nocar 0.268 107 Kenya 0.334 107 Peru-on-Camisea 0.167 108 Rus-KomiRep-psc 0.185 108 Slovakia 0.268 108 Alb-oil sands 0.334 108 China-NewPSC 0.167 109 Nig-off<800m 0.182 109 Peru-on-Camisea 0.267 109 India-psc-nocar 0.332 109 Togo 0.166 110 Nova Scotia-off 0.182 110 Bangladesh 0.266 110 Guat-97r-15 0.332 110 Nig-off<800m 0.165 111 China-Ons-Frontier 0.182 111 Sierra Leone 0.265 111 Bangladesh 0.331 111 Namibia 0.165 112 S Australia 0.181 112 China-Onsh- 0.265 112 Nig-off<500m 0.33 112 Canada-NWTerr 0.164 Frontier 113 Austr-N-Terr 0.181 113 Neth Antilles 0.264 113 Cote dIv-off-dp 0.329 113 New S Wales 0.162 114 Queensland 0.181 114 Italy-on 0.263 114 Namibia 0.329 114 India-psc-nocar 0.161 115 Victoria 0.181 115 China-off 0.263 115 China-off 0.328 115 Gambia 0.16 116 Albania-on-93r 0.181 116 China-Ons-Reg 0.262 116 China - Onsh- Front 0.328 116 Tonga 0.16 117 Mali 0.181 117 Nova Scotia-off 0.261 117 Kaz-Elf-Temir 0.327 117 Korea-North 0.16 118 Bangladesh 0.18 118 Korea-North 0.26 118 Tonga 0.327 118 Malay-off-dp 0.159 119 Malay-off-dp 0.18 119 China-NewPSC 0.258 119 Panama 0.327 119 Nova Scotia-off 0.158 120 Peru-on-Camisea 0.18 120 New S Wales 0.258 120 Suriname 0.326 120 Suriname 0.157 121 Lithuania 0.18 121 Korea-South 0.257 121 Tanz-Texaco 0.326 121 Nig-off<500m 0.156 122 China-Ons Reg 0.179 122 New Zealand 0.257 122 Albania-off-new 0.326 122 Albania-off-new 0.153 123 China-off 0.178 123 Nig-off<500m 0.256 123 China-Onsh-Gen 0.325 123 Albania-on-93r 0.153 124 Neth Antilles 0.177 124 Albania-on-93r 0.255 124 Nova Scotia-off 0.325 124 Kaz-Elf-Temir 0.152 125 Alb-oil sands 0.176 125 Algeria-min 0.255 125 Malay-off-dp 0.325 125 Jordan 0.151 126 Korea-North 0.176 126 Morocco-off-dp 0.255 126 Gambia 0.324 126 Cambodia-on-gen 0.151 127 Morocco-off-dp 0.176 127 Albania-off-new 0.254 127 Morocco-off-dp 0.323 127 S Australia 0.15 128 Cote dIv-off-dp 0.176 128 Gambia 0.254 128 Neth Antilles 0.323 128 Austr-N-Terr 0.15 129 Morocco-off-sh 0.175 129 Morocco-off-sh 0.252 129 Albania-on-93r 0.322 129 Queensland 0.15 130 Cambodia-on-gen 0.174 130 Uganda-mdl 0.251 130 Korea-North 0.319 130 Victoria 0.15 131 Sierra Leone 0.174 131 Cambodia-on-gen 0.251 131 Morocco-off-sh 0.319 131 Burundi 0.149 132 Italy-on 0.173 132 Burundi 0.25 132 New S Wales 0.316 132 Panama 0.148 133 Gambia 0.172 133 Kaz-Elf-Temir 0.249 133 China-NewPSC 0.314 133 Alb-oil sands 0.148 134 Tasmania 0.171 134 Tonga 0.248 134 Nig-off<200m 0.314 134 Zaire 0.147 20 75 million barrels 150 million barrels 300 million barrels Project Rank Name ROR Rank Name ROR Rank Name ROR Rank Name ROR 135 Liberia 0.17 135 India-psc-carry 0.247 135 Zaire 0.313 135 Eg-Med-BG 0.146 136 Albania-off-new 0.17 136 Somalia 0.246 136 JDA 0.313 136 Somalia 0.146 137 Ras Al-Khaimah 0.17 137 Suriname 0.246 137 India-psc-carry 0.312 137 Ras Al-Khaimah 0.146 138 Slovakia 0.17 138 Jordan 0.243 138 Turkmenistan 0.31 138 Ecuador-Triton 0.145 139 W Australia 0.169 139 Newf-Hibernia 0.242 139 Burundi 0.31 139 JDA 0.145 140 Nig-off<500m 0.169 140 S Australia 0.242 140 Jordan 0.309 140 Nig-off<200m 0.144 141 India-psc-carry 0.168 141 Austr-N-Terr 0.242 141 Ecuador-Triton 0.309 141 China-Ons- 0.143 Front 142 Burundi 0.165 142 Queensland 0.242 142 Ukraine-96r 0.306 142 Tasmania 0.142 143 Cambodia-Prem 0.161 143 Victoria 0.242 143 Guinea 0.306 143 Lebanon-off 0.142 144 Algeria-min 0.161 144 Zaire 0.241 144 Cambodia-on-gen 0.302 144 Ukraine-96r 0.142 145 Thai-off-dp 0.16 145 Turkmenistan 0.241 145 Sicily 0.302 145 Guinea 0.141 146 PNG-gen 0.16 146 JDA 0.24 146 Congo-Kitina 0.301 146 China-off 0.141 147 Ukraine-96r 0.16 147 Nig-off<200m 0.24 147 Eg-Med-BG 0.3 147 W Australia 0.141 148 Ethiopia 0.159 148 Panama 0.239 148 S Australia 0.3 148 Turkmenistan 0.14 149 Korea-South 0.158 149 Ukraine-96r 0.239 149 Austr-N-Terr 0.3 149 China-Onsh-Gen 0.139 150 Tonga 0.158 150 Eg-Med-BG 0.236 150 Queensland 0.3 150 Uganda-mdl 0.139 151 Nepal-Shell 0.157 151 Ethiopia 0.235 151 Victoria 0.3 151 Ethiopia 0.139 152 Turkmenistan 0.157 152 Liberia 0.234 152 Kyrgyzstan-psc 0.299 152 Sicily 0.138 153 Bolivia-new-ntr 0.155 153 Cambodia-Prem 0.233 153 Ukraine-Krymg 0.299 153 Cambodia-Prem 0.138 154 Bolivia-new-trd 0.155 154 Lebanon-off 0.232 154 Bolivia-new-ntr 0.297 154 Bolivia-new-ntr 0.138 155 Dubai 0.155 155 Tasmania 0.231 155 Bolivia-new-trd 0.297 155 Bolivia-new-trd 0.138 156 Yem-Nimir 0.154 156 Guinea 0.23 156 T&T-on-gen 0.296 156 Korea-South 0.138 157 Nig-off<200m 0.153 157 Congo-Kitina 0.23 157 Brunei-off>10ml 0.295 157 Newf-Hibernia 0.138 158 Suriname 0.153 158 Bolivia-new-ntr 0.23 158 Somalia 0.294 158 Morocco-off-dp 0.138 159 Ghana 0.153 159 Bolivia-new-trd 0.23 159 Ajman-Scimitar 0.293 159 Algeria-min 0.137 160 Jordan 0.152 160 W Australia 0.229 160 Uzbekistan 0.293 160 Kyrgyzstan-psc 0.137 161 JDA 0.152 161 Rus-KomiRep-psc 0.228 161 Ethiopia 0.29 161 Ukraine-Krymg 0.136 162 Cayman Isl 0.151 162 Nepal-mdl 0.228 162 Romania 0.289 162 Nepal-mdl 0.136 163 Nepal-mdl 0.149 163 Ecuador-Triton 0.226 163 Bulgaria-off-dp 0.288 163 T&T-on-gen 0.136 164 Lebanon-off 0.148 164 Guat-97r-30 0.224 164 Brunei-off<10ml 0.288 164 Morocco-off-sh 0.135 165 Eg-Med-BG 0.147 165 Nepal-Shell 0.224 165 Tasmania 0.288 165 Congo-Kitina 0.135 166 Congo-gen 0.146 166 Ukraine-Krymg 0.224 166 Canada-NWTerr 0.288 166 Uzbekistan 0.134 167 Uzbekistan 0.145 167 Ghana 0.224 167 Lebanon-off 0.287 167 Ghana 0.134 168 T&T-off-sh-psc 0.145 168 Alb-oil sands 0.224 168 Br Virgin isl 0.287 168 Guat-97r-30 0.134 169 Zaire 0.144 169 Cayman Isl 0.223 169 Nepal-mdl 0.287 169 Rus-KomiRep- 0.132 psc 170 Congo-Kitina 0.144 170 Sicily 0.222 170 Fujairah 0.286 170 Ajman-Scimitar 0.132 21 75 million barrels 150 million barrels 300 million barrels Project Rank Name ROR Rank Name ROR Rank Name ROR Rank Name ROR 171 Guat-97r-30 0.143 171 Mozambique 0.222 171 W Australia 0.286 171 Nepal-Shell 0.132 172 Mozambique 0.143 172 Uzbekistan 0.222 172 Cambodia-Prem 0.285 172 Mozambique 0.132 173 Kaz-Elf-Temir 0.142 173 Brunei-off>10ml 0.22 173 Laos 0.285 173 Benin 0.131 174 Ukraine-Krymg 0.14 174 Ajman-Scimitar 0.22 174 Benin 0.284 174 India-psc-carry 0.13 175 Benin 0.138 175 Kyrgyzstan-psc 0.22 175 Ghana 0.283 175 Thai-off-dp 0.129 176 Seychelles 0.138 176 T&T-on-gen 0.219 176 Col-trd 0.282 176 Laos 0.128 177 Ajman-Scimitar 0.137 177 Thai-off-dp 0.216 177 Liberia 0.281 177 Chile 0.128 178 Netherlands-95 0.136 178 Bulgaria-off-dp 0.216 178 Uganda-mdl 0.279 178 Bulgaria-off-dp 0.126 179 Guinea 0.135 179 Benin 0.215 179 Brunei-ons 0.279 179 Liberia 0.126 180 Sudan-new 0.135 180 PNG-gen 0.214 180 Seychelles 0.279 180 Seychelles 0.124 181 Indon-PreT-frt 0.135 181 Yem-Nimir 0.214 181 Guat-97r-30 0.278 181 Timor Gap- 0.123 ZOCA 182 Indon-eor-frt 0.135 182 Brunei-off<10ml 0.213 182 Cayman Isl 0.278 182 Congo-gen 0.123 183 T&T-on-gen 0.134 183 Congo-gen 0.212 183 Chile 0.278 183 Dubai 0.123 184 Brunei-off>10ml 0.134 184 Br Virgin isl 0.21 184 Mozambique 0.276 184 Cameroon-Other 0.117 185 Panama 0.133 185 Fujairah 0.21 185 Cameroon-Other 0.276 185 Cayman Isl 0.116 186 Sicily 0.133 186 Seychelles 0.21 186 Dubai 0.275 186 T&T-off-sh-psc 0.116 187 Libya 0.132 187 Timor Gap-ZOCA 0.209 187 Rus-KomiRep-psc 0.274 187 Indon-eor-frt 0.114 188 Timor Gap-ZOCA 0.132 188 Laos 0.208 188 Rus-on-Elf 0.273 188 PNG-gen 0.114 189 Bulgaria-off-dp 0.131 189 Cameroon-Other 0.206 189 PNG-gen 0.272 189 Eg-Med-Teikoku 0.113 190 Ecuador-Triton 0.131 190 Chile 0.206 190 Timor Gap-ZOCA 0.271 190 Indon-PreT-frt 0.112 191 Thai-off-sh 0.128 191 T&T-off-sh-psc 0.206 191 Nepal-Shell 0.269 191 Guinea Bissao 0.11 192 Netherlands-old 0.127 192 Netherlands-95 0.205 192 Netherlands-95 0.267 192 Netherlands-95 0.107 193 Brunei-off<10ml 0.127 193 Dubai 0.204 193 Indon-eor-frt 0.266 193 Sudan-old 0.107 194 Sudan-old 0.126 194 Brunei-ons 0.204 194 Bolivia-gen-old 0.265 194 Bioko-old 0.105 195 Cameroon-Other 0.126 195 Indon-eor-frt 0.203 195 Rus-gen-jv 0.264 195 Viet-psc-Oxy 0.104 196 Indon-off>1500m 0.125 196 Romania 0.203 196 Rus-gen-jv-1997 0.261 196 Brunei-off>10ml 0.103 197 Br Virgin isl 0.124 197 Indon-PreT-frt 0.201 197 T&T-off-sh-psc 0.259 197 Romania 0.103 198 Fujairah 0.123 198 Libya 0.201 198 Umm Al-Qaiwan 0.259 198 Libya 0.102 199 Azerbaijan-AIOC 0.121 199 Col-trd 0.2 199 Yem-Nimir 0.258 199 Col-trd 0.102 200 Chile 0.121 200 Rus-on-Elf 0.197 200 Azerbaijan-AdPt 0.258 200 Fujairah 0.102 201 Brunei-ons 0.118 201 Sudan-old 0.196 201 Newf-Hibernia 0.258 201 Congo-Nkossa 0.101 202 Indon-PreTert 0.117 202 Netherlands-old 0.195 202 Indon-PreT-frt 0.258 202 Bolivia-gen-old 0.101 203 Guinea Bissao 0.117 203 Eg-Med-Teikoku 0.194 203 Guinea Bissao 0.257 203 Indon-off>1500m 0.1 204 Azerbaijan-AdPt 0.117 204 Guinea Bissao 0.193 204 Congo-gen 0.256 204 Thai-off-sh 0.099 205 Col-mdl-95 0.117 205 Azerbaijan-AIOC 0.192 205 Netherlands-old 0.255 205 Br Virgin isl 0.098 206 Eg-Med-Teikoku 0.115 206 Myanmar-on-Amoc 0.191 206 Thai-off-dp 0.254 206 Congo-PNGF 0.098 22 75 million barrels 150 million barrels 300 million barrels Project Rank Name ROR Rank Name ROR Rank Name ROR Rank Name ROR 207 Thai-on-Khorat 0.112 207 Sudan-new 0.188 207 India-Enron 0.253 207 Sudan-new 0.098 208 Abu Dhabi-Nom 0.112 208 India-Enron 0.187 208 Congo-Nkossa 0.252 208 Myanmar-on- 0.098 Amoc 209 Azerbaijan-Rfac 0.109 209 Azerbaijan-AdPt 0.187 209 Bioko-old 0.251 209 Cote dIv-off-sh 0.098 210 Nor-Barents Sea 0.108 210 Indon-off>1500m 0.186 210 Cameroon-RdR 0.249 210 Cameroon-RdR 0.098 211 Nor-North Sea 0.108 211 Congo-Nkossa 0.186 211 Viet-psc-Oxy 0.249 211 Brunei-off<10ml 0.098 212 India-Enron 0.107 212 Viet-psc-Oxy 0.185 212 Eg-Med-Teikoku 0.247 212 Nor-Barents Sea 0.097 213 Col-trd 0.106 213 Azerbaijan-Rfac 0.185 213 Myanmar-on-Amoc 0.247 213 Nor-North Sea 0.097 214 Congo-Nkossa 0.106 214 Umm Al-Qaiwan 0.183 214 Azerbaijan-Rfac 0.246 214 Yem-Nimir 0.097 215 Cameroon-RdR 0.106 215 Rus-Sakhalin2 0.182 215 Azerbaijan-AIOC 0.246 215 Oman-psc 0.097 216 Oman-psc 0.105 216 Cameroon-RdR 0.181 216 Congo-PNGF 0.242 216 Rus-on-Elf 0.094 217 Kyrgyzstan-psc 0.104 217 Bioko-old 0.18 217 Nor-Barents Sea 0.241 217 Netherlands-old 0.094 218 Cote dIv-off-sh 0.102 218 Rus-gen-jv 0.179 218 Nor-North Sea 0.241 218 Indon-PreTert 0.094 219 Romania 0.099 219 Indon-PreTert 0.178 219 T&T-off-gen 0.241 219 T&T-off-gen 0.093 220 Umm Al-Qaiwan 0.099 220 Nor-Barents Sea 0.176 220 Indon-off>1500m 0.238 220 Eg-GOS-Apache 0.091 221 Rus-Sakhalin2 0.096 221 Nor-North Sea 0.176 221 Libya 0.238 221 Brunei-ons 0.091 222 Thai-on-C 0.096 222 Thai-off-sh 0.176 222 Sudan-old 0.235 222 Rus-Sakhalin2 0.09 223 Rus-on-Elf 0.093 223 Rus-gen-jv-1997 0.175 223 Yem-BP 0.235 223 Eg-on-Teikoku 0.088 224 Laos 0.093 224 Oman-psc 0.173 224 Oman-psc 0.234 224 Thai-on-Khorat 0.088 225 Rus-gen-jv 0.093 225 Congo-PNGF 0.172 225 Abu Dhabi-Nom 0.234 225 Georgia 0.087 226 Georgia 0.092 226 Cote dIv-off-sh 0.171 226 Viet-psc-Lasmo 0.231 226 Yem-BP 0.085 227 Viet-psc-Oxy 0.091 227 Col-mdl-95 0.17 227 Indon-PreTert 0.23 227 Rus-gen-jv-1997 0.083 228 Gab-off-sh-psc 0.091 228 Eg-GOS-Apache 0.165 228 Rus-Sakhalin2 0.23 228 Rus-gen-jv 0.083 229 Yem-Revised 0.089 229 Viet-psc-Lasmo 0.164 229 Col-mdl-95 0.226 229 Indon-marg-frt 0.082 230 Indon-marg-frt 0.088 230 Abu Dhabi-Nom 0.164 230 Yem-Revised 0.224 230 Eg-GOS-Repsol 0.082 231 Congo-PNGF 0.088 231 Yem-Revised 0.164 231 Thai-off-sh 0.222 231 India-Enron 0.081 232 Indon-94-inc 0.088 232 Bolivia-gen-old 0.162 232 Indon-94-inc 0.222 232 Eg-Med-Amoco 0.081 233 Eg-GOS-Apache 0.087 233 Eg-on-Teikoku 0.162 233 Indon-marg-frt 0.222 233 Indon-94-inc 0.081 234 Eg-on-Teikoku 0.086 234 T&T-off-gen 0.161 234 Sudan-new 0.221 234 Viet-psc-Lasmo 0.08 235 Rus-gen-jv-1997 0.084 235 Myanmar-on-mdl 0.161 235 Georgia 0.22 235 Eg-on-Shell 0.079 236 Ven-Paria E 0.082 236 Thai-on-Khorat 0.16 236 Eg-GOS-Apache 0.22 236 Eg-on-Mobil 0.079 237 Angola-off-mdl 0.081 237 Gab-off-sh-psc 0.156 237 Myanmar-on-mdl 0.219 237 Umm Al-Qaiwan 0.078 238 Thai-Gulf 0.08 238 Indon-94-inc 0.156 238 Honduras 0.216 238 Gab-off-sh-psc 0.077 239 Myanmar-on-Amoc 0.08 239 Indon-marg-frt 0.155 239 El Salvador 0.215 239 Thai-on-C 0.077 240 Nig-Inland 0.079 240 Georgia 0.155 240 Nig-Inland 0.215 240 Azerbaijan-AdPt 0.076 241 T&T-off-gen 0.078 241 Myanmar-on-Yuk 0.155 241 Eg-on-Teikoku 0.215 241 Myanmar-on-mdl 0.076 242 Eg-GOS-Repsol 0.077 242 Eg-Med-Amoco 0.154 242 Eg-on-Mobil 0.213 242 Myanmar-on-Yuk 0.076 23 75 million barrels 150 million barrels 300 million barrels Project Rank Name ROR Rank Name ROR Rank Name ROR Rank Name ROR 243 Eg-Med-Amoco 0.077 243 Yem-BP 0.153 243 Albania-off-old 0.213 243 Eg-on-IEOC 0.075 244 Bioko-old 0.077 244 Eg-GOS-Repsol 0.152 244 Myanmar-on-Yuk 0.213 244 Nig-Inland 0.075 245 Rus-gen-psc 0.074 245 Eg-on-Mobil 0.151 245 Eg-on-Shell 0.212 245 Albania-off-old 0.075 246 Albania-off-old 0.072 246 Eg-on-Shell 0.151 246 Cote dIv-off-sh 0.211 246 Col-mdl-95 0.073 247 Bahrain 0.071 247 Nig-Inland 0.148 247 Thai-on-Khorat 0.21 247 Yem-Revised 0.07 248 Eg-on-IEOC 0.07 248 Albania-off-old 0.146 248 Eg-Med-Amoco 0.207 248 Honduras 0.07 249 Eg-on-Shell 0.07 249 Thai-on-C 0.146 249 Eg-GOS-Repsol 0.205 249 Eg-on-Marathon 0.068 250 Indon-marg 0.063 250 Eg-on-IEOC 0.143 250 Yugosl-Serbia 0.205 250 Thai-Gulf 0.067 251 Nig-Niger Delta 0.059 251 Thai-Gulf 0.135 251 Eg-on-Marathon 0.205 251 Ven-Paria E 0.064 252 Aruba 0.058 252 Rus-gen-psc 0.135 252 Gab-off-sh-psc 0.201 252 Abu Dhabi-Nom 0.064 253 Viet-psc-Lasmo 0.057 253 Honduras 0.131 253 Thai-on-C 0.201 253 El Salvador 0.062 254 Myanmar-on-mdl 0.052 254 Eg-on-Marathon 0.13 254 Kaz-Tengiz 0.199 254 Bahrain 0.061 255 Sharjah 0.046 255 Bahrain 0.128 255 Eg-on-IEOC 0.198 255 Indon-marg 0.057 256 Eg-on-Mobil 0.046 256 Indon-marg 0.125 256 Yem-Exxon 0.196 256 Nig-Niger Delta 0.052 257 Ven-Delta C 0.045 257 Yugosl-Serbia 0.121 257 Thai-Gulf 0.195 257 Yem-Exxon 0.049 258 Myanmar-on-Yuk 0.043 258 Nig-Niger Delta 0.12 258 Peru-on-BL-52 0.192 258 Peru-on-BL-52 0.049 259 Malay-off-sh 0.042 259 Ven-Paria E 0.119 259 Rus-gen-psc 0.19 259 Kaz-Tengiz 0.047 260 Honduras 0.04 260 Sharjah 0.113 260 Indon-marg 0.188 260 Rus-gen-psc 0.041 261 Bolivia-gen-old 0.039 261 El Salvador 0.111 261 Bahrain 0.187 261 Aruba 0.041 262 Indon-conv 0.038 262 Yem-Exxon 0.109 262 Nig-Niger Delta 0.183 262 Yugosl-Serbia 0.04 263 Ven-Guanare 0.035 263 Kaz-Tengiz 0.107 263 Sharjah 0.179 263 Azerbaijan-Rfac 0.039 264 Yem-BP 0.031 264 Aruba 0.106 264 Yem-Crescent 0.164 264 Ven-Delta C 0.037 265 Yugosl-Serbia 0.025 265 Angola-off-mdl 0.103 265 Algeria-psc-gen 0.163 265 Azerbaijan-AIOC 0.036 266 Neutr Zone-on 0.024 266 Peru-on-BL-52 0.103 266 Ven-Paria E 0.155 266 Algeria-psc-gen 0.034 267 Algeria-psc 0.023 267 Algeria-psc-gen 0.097 267 Indon-conv 0.151 267 Indon-conv 0.031 268 Ven-Paria W 0.023 268 Indon-conv 0.092 268 Qatar-mdl 0.149 268 Ven-Guanare 0.031 269 Algeria-psc-gen 0.016 269 Ven-Delta C 0.083 269 Aruba 0.149 269 Angola-off-mdl 0.03 270 Neutr Zone-off 0.012 270 Algeria-psc 0.083 270 Algeria-psc 0.142 270 Qatar-mdl 0.027 271 Eg-on-Marathon 0.01 271 Qatar-mdl 0.081 271 Neutr Zone-on 0.141 271 Algeria-psc 0.027 272 Peru-on-BL-52 0.01 272 Neutr Zone-on 0.078 272 Yem-Norsk Hydro 0.138 272 Yem-Crescent 0.024 273 Kaz-Tengiz 0.006 273 Viet-psc-BHP 0.075 273 Viet-psc-BHP 0.137 273 Neutr Zone-on 0.022 274 Yem-Oxy 0 274 Ven-Guanare 0.074 274 Angola-off-mdl 0.126 274 Sharjah 0.009 275 El Salvador 0 275 Malay-off-sh 0.074 275 Syria-psc-mdl 0.123 275 Malay-off-sh 0.007 276 Qatar-mdl 0 276 Yem-Crescent 0.069 276 Ven-Delta C 0.123 276 Ven-Paria W 0.006 277 Viet-psc-BHP 0 277 Ven-Paria W 0.064 277 Malay-off-sh 0.12 277 Ven-La Ceiba 0 278 Yem-Crescent 0 278 Neutr Zone-off 0.06 278 Neutr Zone-off 0.119 278 Iran 0 24 75 million barrels 150 million barrels 300 million barrels Project Rank Name ROR Rank Name ROR Rank Name ROR Rank Name ROR 279 Yem-Norsk Hydro 0 279 Ven-La Ceiba 0.034 279 Ven-Guanare 0.118 279 Ven-Gpiche 0 280 Ven-La Ceiba 0 280 Ven-Gpiche 0.033 280 Yem-Oxy 0.118 280 Yem-Oxy 0 281 Syria-psc-mdl 0 281 Yem-Norsk Hydro 0.027 281 Ven-Paria W 0.109 281 Neutr Zone-off 0 282 Iran 0 282 Syria-psc-mdl 0.018 282 Syria-Unocal 0.096 282 Syria-psc-mdl 0 283 Ven-Gpiche 0 283 Iran 0.007 283 Ven-La Ceiba 0.083 283 Syria-Unocal 0 284 Syria-Unocal 0 284 Yem-Oxy 0.004 284 Ven-Gpiche 0.082 284 Viet-psc-BHP 0 285 Yem-Exxon 0 285 Syria-Unocal 0 285 Iran 0.079 285 Yem-Norsk 0 Hydro 25 Annex 3: Market Opening and Security of Oil Supply The government has policy concerns about the adequacy of oil storage to meet civilian and national security needs in situations where some regions of the country may become more import-dependent, for example, if market forces dictate that more Chinese crude oil should be exported and more of the refiners' requirements be met by imports. National security needs for oil products must be dealt with as part of defense and energy policies, which is something outside the scope of the present report. Concerns about security of the civilian oil supply will have to be better understood before specific prescriptions can be put forward. However, as an aid to perspective on the government's concerns and possible means dealing with them, we offer the following observations. Global security of oil supply is seen as having greatly improved in the past 20 years, as a result of such factors as the greater geographical dispersion of sources of supply, the presence of the International Energy Agency (IEA) and the existence of the U.S. Strategic Petroleum Reserve (SPR). This improvement was demonstrated during the Iraq-Kuwait crisis in 1990­91: oil supplies were adequately maintained and prices remained at acceptable levels, despite the loss of about 4 million barrels a day of exports, a volume deficit that would have caused severe difficulties for the world economy had it taken place in the 1970s. The existence of the IEA and the SPR arguably benefits all users of imported oil, not just the IEA countries. The progressive liberalization of China's oil imports and exports is likely to increase its dependence on gross imports (the absolute volume of imports). On the other hand, net imports (imports minus exports) are more likely to increase less than they would under a "business as usual" case. Nevertheless it is understandable that prospectively larger gross imports would raise policy concerns in China, just as they have done in other countries. At the same time, those concerns have to be seen in the context of the Chinese economy where the share of oil in the energy mix and the share of imports in that component will remain much less than that of Europe or the United States (both about 40 percent oil, more than half of which is imported). As a generalization, the current dominant policy thinking among the industrial countries is that security of energy supply is best assured by having a varied mix of energy sources, in which the oil component is fed from a diversity of sources by a mix of suppliers competing vigorously against each other and where there are no restrictions, for example, in terms of access to foreign currency, on the suppliers' ability to make full use of international sources of supply. This is consistent with the proposals for the reform of sector's structure and with the view expressed in this report that the best way to improve China's oil supply is to increase E&D, partly by greater IOC participation. The International Energy Program (IEP) was signed by 16 countries in 1974 and the IEA was formed. The IEA currently has 24 member countries. The countries participating in the IEP agreement have committed themselves to maintaining emergency oil reserves 26 equivalent to at least 90 days of net oil imports, having ready a program of oil demand restraint, and participating in oil allocation through IEP emergency measures. Net exporting countries do not have stockholding obligations under IEP with the exception of member countries of the European Union. The countries have different types of stockholding systems: 14 countries have only company stocks (compulsory and commercial stocks), 2 countries have company and government stocks (United States and Japan), 6 countries have company and agency stocks (with cost sharing arrangements), and 2 countries have a mix of all three types of stocks. Whether stocks are held by the government or by the oil companies, though, this is an expensive way of providing some security of civilian oil supply. It is therefore a question for discussion whether China can afford the "luxury" of an oil security stockpile, whether financed publicly or imposed as an additional cost of operations on the commercial sector and therefore having to be recovered in market prices. Another approach is for companies from an important dependent country to develop overseas sources of equity or "owned" crude oil production, with a view to those supplies then being dedicated to that country's domestic market. Japan has done this in the past through its national company's operations in the Kuwait-Saudi Neutral Zone. We understand that CNPC's share of the Sudan Greater Nile Project oil production is imported to China. This approach may make sense where the cost of developing the foreign sources is demonstrably cheaper than that of domestic oil, where any potential penalties--such as oil quality in relation to domestic refinery configurations--are properly accounted for, and where there is real confidence in the security of the source in question. The stream of deemed "secure" imports would of course have to be established in non-emergency conditions, rather than be diverted from other markets in times of crisis. And any costs that this approach imposes on the operating company would have to be made explicit and be offset by the government, especially if the company were a state-owned enterprise (SOE) in the course of privatization. A approach related to that described in the previous paragraph involves some kind of state- to-state trading. The concept is to enter into arrangements with a foreign country, directly or more likely with its state company, which is deemed to provide a "secure" supply source, and to establish a dedicated stream of oil from that source to the importing jurisdiction. This approach may make sense in some circumstances, but it appears to be less widely used than was the case in the supply crisis atmosphere of the 1970s and early 1980s when arrangements with the state companies of exporting countries were seen as potentially key elements in providing supply security. The approach can entail many issues, such pricing, quality, transportation, scheduling, and allocation of these imports among users. These issues tend to become more difficult to deal with to the extent that markets in the importing jurisdiction are being opened up to competition and when state companies are partially or fully listed on the stock exchange. Finally, consideration has been given in some countries to mandating that a proportion of oil-using equipment should have dual fuel capability, to enable oil use to be curtailed in an emergency. While this is technically feasible, for instance, in electricity generation, it too imposes the cost burdens of such equipment and of the "standby" alternative fuel supply 27 capability. Our sense is that fuel-switching capability for security reasons has diminished and that where such equipment is installed now, it has more to do with taking advantage of fuel market price opportunities than with security of supply. 28 Annex 4: "Qualification" or "Certification" of Participants in Oil and Gas Operations 1. It is established practice in many countries for the government or the responsible agency to set out requirements that must be met by companies wishing to take part in certain petroleum activities. 2. The purpose, generally speaking, is to ensure that the intending participant is qualified to carry out the activity. "Qualification" may relate to financial or technical capability, or both, and may also require reference to demonstrated experience and success in the same activity elsewhere. 3. A balance clearly needs to be struck between, on the one hand, the desirability of having qualified operators and, on the other hand, of having many companies active in the various fields of activity to derive the benefits of competitive markets. 4. Also, qualification should be based on identifiable, objective criteria and the government or its agency should have little or no discretion to decide whether a bidder meets those criteria. 5. Examples of qualifying criteria include the following: · Business incorporation under some predefined conditions, and identification of key staff and directors. · Financial capability: the demonstration of a certain net worth in the most recent audited financial statements. · Technical capability: the achievement of certain defined production volumes in relevant petroleum operations elsewhere. 6. Examples of activities where "qualification" or "certification" might be required are the following: · Exploration and development operations, particularly offshore. · Construction and operation of major facilities, such as processing plants, long- distance pipelines, or liquefied natural gas (LNG) terminals. · Participation in energy commodity markets (natural gas), and serving small customers in those markets. 7. "Qualification" or "certification" by government authorities of operators in certain businesses needs to be distinguished from the following: · Qualification by industry participants of contractors or business partners, again on the basis of financial or, more often, technical capability. This is a matter between private 29 parties. For example, an oil company might have a set of criteria the drilling contractors would have to meet to bid on drilling work for that company. · The application of standards by government authorities to all participants in a sector. For example, a regulatory agency might require that certain standards of product handling and of equipment be met to take part in the LPG business (standards for propane cylinders). This is a very common type of regulation affecting businesses of all kinds. The important point is that standards should be applied and enforced equally on all parties. Standards and "Unfair competition" 8. At least two cases of "unfairness" came to the attention of the working group in this general context: · Unfair competition in the retail gasoline market from stations that do not meet industry standards. The solution lies in the area of enforcement. · Well drilling by third parties on the margins of oil or gas fields operated by state- owned enterprises (SOEs) under license from the state, resulting in the SOEs' oil or gas being in effect "stolen" by these operators. The solution lies in the area of regulation and enforcement: every well should have an approval before drilling starts, and approvals should only be given where the entity drilling the well has proper title to the mineral rights. 30 Annex 5: A Comprehensive Listing of Proposed Regulatory Activity Upstream3 Mineral Rights and Fiscal Management 1. Creating a geographical reference scheme for all petroleum-prospective areas. 2. Maintaining a bank of information as to which petroleum mineral rights are under license, to whom, and for what period.4 3. Providing access for bona fide oil and gas operators to mineral rights that are not under license, for purposes of exploration, development and production of their petroleum resources, on such terms as the Government of China may from time to time determine. 4. Monitoring that the licenses are maintained in good standing by the lessees, for example, by their observing all the terms of the respective license. 5. Where the petroleum mineral rights is accessed by a production-sharing contract, supervising the terms of and performance under such a contract. 6. Administering all issues relating to surface rights that are affected by oil and gas operations, including the arbitration of disputes between surface rights owners and oil and gas lessees (in the alternative, this regulatory activity could be dealt with by independent mediation or arbitration boards established specifically for the purpose). Fiscal 7. Maintaining a comprehensive system for accounting of production, reinjection, sale and other disposal of all oil, gas, gas liquids, sulfur, and other fluids produced. 8. Assessing and collecting royalties and all other revenues associated with the use of the license, by applying such royalties and other fiscal imposts as the Government of China may from time to time determine. Technical--Engineering Related 9. Dealing with applications to carry out all activities and put in place all plant and facilities that have to do with upstream oil and gas, such as exploration, appraisal, development, offshore structures, gathering pipelines, field processing of oil and gas, enhanced recovery schemes, and eventual abandonment and removal of such equipment and clean-up of sites where plant and facilities had been installed.5 3The term "upstream" denotes all activity upstream of the points at which processed clean oil moves into the pipeline, which takes it to refinery markets, or marketable pipeline gas leaves the processing plant. 4The term "license" is used in relation to the upstream industry to denote any vehicle by which the Government of China provides access to petroleum rights for purposes of exploring and developing their petroleum resources. 5By "deal with" is meant receive, consider, and either approve, approve with conditions, recommend reapplication, or reject. 31 10. Monitoring and administering all subsurface reservoir management and production schemes and practices to ensure the conservation and maximum recovery of petroleum from the reservoir. 11. Monitoring, inspecting, auditing, and ensuring compliance with all requirements for the construction and operation of all plant and facilities. 12. Maintaining a bank of information about China's petroleum resources and reserves in the form of geological geophysical and engineering data from government agencies and from oil and gas operators and making these data publicly available after any prescribed confidentiality periods. 13. Administering all issues related to subsurface production and ownership disputes that might arise between oil and gas producers. Upstream and Downstream6 Technical--Health, Safety and Environment 14. Developing and enforcing all environmental, safety, and labor standards, rules, and regulations that are specific to the oil and gas industry, for example, environmental, in regard to environmental impact assessment, facility siting, air, water and solid waste discharges; design standards for pollution control equipment and for public and worker safety, in regard to well control, pipelines and distribution systems; and worker safety, in regard to all work site hazards. 15. Carrying out auditing, inspection, and collection of environmental and operational data to ensure compliance with standards and license requirements. 16. Investigating accidents, including equipment failures, that have or could affect public, worker or environmental safety, to determine whether the accident or failure was related to a deficiency in the design or application of the regulations. 17. Collecting and maintaining data on the location and status of wells, pipelines, and other facilities. Downstream Technical 18. Dealing with all technical, including environmental, aspects of applications for the development, beyond the oil or gas field, of pipeline and other facilities intended to bring oil to refinery markets and gas to final consumers, therefore including long- distance pipelines for oil and gas and distribution systems for gas. Economic--Monopolies: Rates and Service 19. Setting or approving rates and all other service conditions of oil and gas pipelines. 20. Setting or approving rates and all other service conditions of gas distribution systems. 21. Carrying out all the information gathering, storage, and manipulation activities required to set or approve such rates, including, for example, maintaining, according to a uniform system of accounting, a comprehensive data series on the investments, 6"Downstream" means all activities not included in "upstream." See footnote 1. 32 depreciation, original and depreciated rates bases of the regulated entities to provide a basis for determination of their costs of service or a benchmark for the application of other forms of economic regulation such as price caps. 22. Performing audits and inspections to ensure that only approved rates are being charged and that services are being properly provided in relation to approved standards. 23. Dealing with complaints by users of the regulated pipelines and distribution systems as to rates charged and services provided. Economic--Monopolies: Project Approval 24. Receiving and ruling on applications for approval of significant capital expenditures by regulated enterprises, including applications for the right to take lands owned by others for rights of way that are found by the regulator to be required in the public interest. 25. Receiving and ruling on applications for franchises for gas distribution systems. 26. Establishing and applying criteria for gas distribution systems to be extended or improved to provide service to a previously unserviced area or client. Process and Information Transparency: Upstream and Downstream, Technical and Economic 27. Processes that, while safeguarding state and commercial secrets, provide comprehensive information about the information requirements and procedures to obtain all the approvals referred to above about compliance required, about the rights of applicants for approvals, and the rights of persons and organization that may wish to support or oppose the grant of those approvals, and about the rights and responsibilities of successful applicants. 28. Processes that, while safeguarding state and commercial secrets, provide for regular reporting to government and to the public on the results of all the regulator activity set out in the foregoing in terms both of data and narratives. 33 Annex 6: Environmental Regulation 1. This annex focuses on the aspects of technical regulation related to worker safety, public safety, environmental protection, engineering and environmental standard setting, operational practices, and operational compliance of oil and gas enterprises.7 2. The joint working group identified the need to examine the role of technical, environmental, and public and worker safety issues with respect to recommendations regarding change to China's oil and gas regulatory framework. The working group recognizes the importance of effective environmental and safety regulatory systems in achieving worker safety and environmental policy objectives as established by the government. In addition, transparent, timely, and efficient operational regulatory processes consistently administered by an independent regulator are critical to ensuring that competitive markets exist. Environmental regulatory functions (similar to economic regulation objectives) can provide a "level playing field" for competitors in resourcing programs necessary to achieve the required level of compliance to environmental and safety standards. Failure to establish these regulatory structures will inevitably lead to a competitive market structure in which the least environmentally responsible enterprises achieve the largest economic advantage. This system penalizes the responsible operator and rewards the worst operator. 3. This annex on environmental regulation sets out to achieve the following objectives: · To describe the typical functions of a "modern" framework for environmental, safety, and technical regulation of the petroleum industry. · To describe the existing oil and gas environmental regulatory framework in China, including environmental standards, environmental impact assessment, and worker and public safety. · To identify issues with the current Chinese environmental regulatory framework. · To provide recommendations on the establishment of new regulatory structures and functions. 7For the purposes of this report, "technical regulation" includes all regulations pertaining to environmental standards, discharge standards, remediation and reclamation requirements, good petroleum operational standards, engineering design standards, geological and reservoir management regulations, public safety requirements, worker safety standards, and other regulatory requirements normally associated with petroleum industry development and operations. 34 Methodology and Limitations of Report 4. The background, analysis, and issues with China's environmental processes contained in this report are based on interviews with representatives of several Chinese state government agencies and oil and gas companies, as well as a review of selected available literature on China's environmental regulatory processes during a two-week mission to Beijing in April 2000. The findings were presented to and discussed with the joint working group, along with international best practice in these areas. The findings are preliminary because additional information on ambient and discharge standards and further interviews with regional and local environmental organizations would be necessary to confirm the findings. Health-Safety-Environmental (HSE) and Technical Regulatory Responsibilities 5. The primary function of a modern regulatory framework is to ensure that resources are developed and marketed in the "public interest" (that is, in a manner that maximizes the benefits of these activities to the public). Ensuring that unwanted effects of resource development to the physical and social environment are minimized is an important component of these regulatory responsibilities. To achieve this goal for China's petroleum industry, a number of environmental and technical or operational regulatory functions must be exercised on behalf of the government. These functions and a rationale for including them as responsibilities within the proposed new approach to regulation of China's petroleum industry are described in the following paragraphs. Environmental Screening, Environmental Impact Assessment, and Permitting Processes for Petroleum Construction Projects 6. Environmental screening and environmental assessment of proposed construction activities (such as drilling a well, conducting seismic appraisal, or constructing pipelines or processing facilities) are important tools for regulatory permitting processes. The regulatory purpose of conducting these reviews is to · examine project alternatives; · ensure that possible prevention and mitigation of adverse environmental impacts have been incorporated into project plans, where possible; and · determine whether a proposed construction project should be permitted to proceed with construction and operation, proceed with modifications, or be rejected. 7. Modern petroleum regulators have generally developed screening criteria and processes to determine the appropriate extent and type of environmental assessment required. Project proposals are screened or categorized to separate routine activities (for which environmental effects can be mitigated and managed through compliance with standards, codes, and guidelines) from more complex projects likely to have significant adverse environmental impacts and require more 35 specific and focused regulatory scrutiny. Complex projects are determined by location (that is, activities in environmentally or socially sensitive areas), scale (larger projects can have broader environmental or social effects), or uniqueness (projects that are unique or utilizing unknown technologies). In many regulatory jurisdictions, the environmental assessment function is a shared responsibility between the petroleum regulator and a national (that is, government) or provincial level ministry with environmental assessment responsibilities. State environmental assessment processes supplement the petroleum regulators' responsibility by conducting more formal environmental assessment review processes for "mega" projects that may have national environmental, social, or economic policy considerations. In these situations, petroleum "mega" projects would be required to get an environmental assessment certificate before proceeding through the more detailed permitting processes. In China's context, the formal Environmental Impact Assessment (EIA) review process for major petroleum projects could be jointly conducted by the new petroleum regulatory agency and the State Environmental Protection Administration (SEPA). 8. Developing specific screening criteria and designing appropriate regulatory review processes for routine and more complex environmental reviews promotes efficiency in the permitting process and focuses regulatory resources where the most environmental benefits can be achieved. Technical and Environmental Standard Setting 9. The regulator in a modern regulatory framework prescribes engineering and environmental standards for the design of drilling programs, pipelines, and field production and processing facilities. Good design ensures that environmental standards are achieved and environmental exceedences or accidents causing environmental damage or creating public safety risks in facilities operations are thereby avoided. Where accidents, incidents, or failures occur and result in environmental damage or risks to the public or workers, the regulator will conduct investigations to identify the cause. Findings from such investigations will be published and utilized to improve design standards, regulations, and/or create improved operating practices, as appropriate. Regulation of Subsurface Production and Reservoir Management Schemes 10. The regulator in a modern regulatory framework oversees the exploitation of resources in a manner that ensures that the public interest is protected during the production phase of petroleum development. This objective is accomplished through such means as establishing the maximum production allowable and permitting reservoir development schemes with the objective of maximizing the volume of oil or gas ultimately recovered. The regulator also provides mechanisms to ensure fair access to resources where more than one enterprise is producing from the same oil or gas field or reservoir. 36 Public Consultation 11. It is now commonplace for regulators to require enterprises or companies proposing to construct projects to review these plans with regional and local authorities and the various publics who might be affected by them. The issues identified during public consultations and recommendations stemming from them are considered by the regulator in making a decision as to whether or not to allow activities to proceed. Inspection and Compliance 12. A modern regulatory framework must have the organizational capacity and the legal authority to inspect petroleum activities and operations to ensure that they are in compliance with standards and permit requirements, as well as to initiate enforcement actions where standards are not being met. Modern regulatory practices are to establish routine monitoring information, which operators must provide to demonstrate their compliance. Monitoring activities are supplemented by routine audits and on-site inspections to ensure that monitoring data are accurate and that design and operations standards are being adhered to. Public Safety 13. Regulatory assessment and permitting, technical standard setting, and compliance and enforcement efforts must ensure that petroleum developments do not create unacceptable risks to the safety of people living near these facilities (sour gas wells, pipelines, and field processing plants). By using modern technical design standards and establishing emergency response planning requirements and procedures, the regulator will maintain the highest possible levels of public safety. Worker Safety 14. Regulatory responsibilities also include establishing acceptable practices designed to ensure the safety of workers in the construction and operation of petroleum facilities. These responsibilities include operability assessment of facility design, review, and specification of operating procedures, and inspection of construction and operating sites to ensure that worker safety standards are maintained. Compliance with worker safety regulatory requirements is the responsibility of the enterprise. The regulator maintains the authority to establish such standards, enforce them, and prosecute companies under the law where standards are not adhered to. China's Current Regulatory Design and Framework 15. Based on the mission's preliminary review of China's existing environmental regulatory system8, it is clear that the structural elements of a comprehensive 8Woodrow Wilson International Center for Scholars. 26 Nov. 1996. The Environment in China: An Overview. http://ecsp.si.edu/ecsplib.nsf/451f9216. Retrieved April 24, 2000. . 37 regulatory framework are in place. SEPA is the primary environmental regulator of China's petroleum industry. Reporting to China's State Council, SEPA administers a comprehensive set of guidelines, laws, regulations, and standards to achieve environmental objectives in a wide spectrum of areas of responsibility. China's environmental regulatory processes benefit from strong technical competencies in areas such as environmental assessment, standard setting, and the environmental sciences. Legal Framework for Environmental Regulation in China 16. Since 1979 China has established a comprehensive environmental legal framework, including the adoption of six national environmental protection laws, all of which would have some application to oil and gas activities:9 · Environmental Protection Law · Marine Environmental Protection Law · Law for Prevention and Treatment of Ambient Air Pollution · Law for Prevention and Treatment of Water Pollution · Law for Prevention and Treatment of Solid Waste · Law for Noise Prevention and Treatment · Regulation on Natural Preservation Area · Regulations of Environmental Management on Construction Project 17. In addition, a number of other elements of China's environmental protection framework have been developed, some of which have direct application to oil and gas activities: · 28 administrative regulations including "Regulations of GOC on the Administration of Environmental Protection in the Exploration and Development of Off-Shore Petroleum"; · 65 sectoral administrative regulations on environment protection (56 promulgated by SEPA; 9 by the State Marine Administration); · 3 special regulations on offshore oil development; · more than 100 labor standards (industrial hygiene); and · more than 900 environment protection regulations issued by local environmental departments of local governments. World Bank, Environment, Human Resources and Urban Development Division, East Asia and Pacific Regional Office, Report No. 9669-CHA. April 1992. "China Environmental Strategy Paper, Volume I: Main Report and Volume II: Annexes." World Resources Institute. January 2000. Laws and Policies to Protect the Environment and Health. http://www.wri.org/wr-98-99/prc2laws.htm. Retrieved April 2000. Xiamen Environmental Protection Bureau. 1996. Environmental Regulations. http://chinavista.com/xiamen/invest/env-reg.html. Retrieved April 2000. 9State Administration of Petroleum and Chemical Industries presentation, April 17, 2000. 38 18. Administratively, environmental regulatory responsibilities and programs are delivered through state and provincial environmental protection agencies (EPAs), and prefectural (municipal) environmental protection bureaus (EPBs). This process primarily applies to onshore activities. Offshore petroleum development activities are regulated principally by the State Ocean Maritime Bureau, which oversees permitting, standard setting (by the state setting the marine standards), and monitoring responsibilities (in association with SEPA and a number of other offshore regulatory agencies). 19. China's legal and administrative framework establishes an environmental regulatory management system based on pollution discharge fees, the "Three Synchronizes," and Environmental Impact Assessment. Pollution Discharge Fees 20. In the past in China, discharges of emissions in excess of established discharge standards are not treated as legal violations. Article 18 of China's Environmental Protection Law states that where limits are exceeded, "a compensation fee shall be charged according to the quantity and concentration of the pollutants released."10 Based on the "polluter pays" principle, China's local EPBs administer a system of effluent fees for permitted discharges and levy fines when these discharge permit levels are exceeded. Effluent discharge fees are collected by local EPBs and redistributed to enterprises for funding pollution reduction or abatement initiatives. Up to 80 percent of these funds can be used to assist enterprises in the installation of pollution control equipment. The remaining 20 percent are used to fund local EPB scientific and promotion activities. Fines for exceeding discharge limits are transmitted to the national government. On September 1, 2000, the "Law for Prevention and Treatment of Ambient Air Pollution" came into force. This new legislation will treat emission discharges in excess of standards as violations, and polluters will be subject to appropriate legal liabilities or remedies. The Three Synchronizes 21. The Three Synchronizes requires that environmental protection measures be incorporated into all new projects at the project planning, design, and implementation or operation phases. These steps are utilized to promote the reduction of pollution through incorporating pollution prevention planning into the conceptual planning and design, during construction, and when facilities go into operation.11 10Dasgupta et al. 1997. Dasgupta, Susmita, and Manul Huq, and David Wheeler. Feb. 1997. Bending the Rules: Discretionary Pollution Control in China. http://www.worldbank.org/nipr/work_paper/1761/index.htm. Retrieved April 2000. 11China Environmental Strategy Paper, 1992; Discussions with SOE representatives, April 19, 2000. 39 Environmental Impact Assessment 22. The other mainstay of China's environmental regulatory framework is the environmental assessment process. Environmental assessment requirements vary under Chinese law depending on the severity of impacts associated with proposed new project construction, expansion, or modifications. Detailed environmental impact statements (EISs) are required for large projects (generally costing more than RMB 200 million) that generally require state environment department approval. For projects with light or very small impacts, a more simplified process requiring completion of environmental impact forms is required (environment impact reports (forms) are approved by local EPBs and are required for projects costing less than RMB 200 million.12 23. On behalf of the enterprise, a "certified organization," designated by the local EPB, prepares an EIS outline for the project. This outline is then reviewed for approval by the appropriate responsible government agency. Following approval of the outline, the detailed EIS is prepared and submitted, with the proposed project design, for approval. Following acceptance of the EIS and approval of the project, the EIS is utilized to monitor the project during the construction phase and to provide structure at the startup phase when pollution control equipment is tested for acceptance or approval to operate. Environmental and Technical Standards and Discharge Permits 24. National environmental ambient and technical pollution discharge standards are established by SEPA. National standards developed by SEPA are submitted to the Standardization Law and Environment Protection Law for review and approval. Currently, 360 national environmental standards have been established by SEPA. National standards are supplemented by many local environmental standards. 25. Provincial, prefectural (municipal) EPBs formulate local standards that usually could only be more stringent than those set nationally. EPBs report to local village or county governments. Local EPBs are responsible for establishing permitted emission levels for regulated discharges and monitoring the permitted enterprises for compliance. Issues or Concerns with the Current Chinese Environmental Regulatory System 26. The following observations, based primarily on interviews with state agencies and enterprise representatives associated with or familiar with China's environmental technical regulatory framework, were discussed with the working group. 12. China Environmental Review: Quarterly newsletter for China Environment, Health http://www.environmental-expert.com/magazine/aer/china/summer/article2.htm. Retrieved April 2000. 40 Complexity of the Environmental Framework 27. A number of observations were made on the complexity of China's environmental and technical regulatory processes. These comments include concerns that in some cases, the EIA and technical standards were some times applied inconsistently to different enterprises. There is a perception that standards and expectations are higher for "richer" and larger enterprises, and conversely that requirements are applied less stringently to smaller, less profitable enterprises. 28. The structural nature of the current multilevel SEPA regulatory framework that relies on state, provincial, county, or local EPAs and EPBs to review environmental impact statements, set standards, monitor for compliance, and collect discharge fees and assign discharge fines creates significant opportunities for inconsistent application of requirements. Overlapping Jurisdictional Responsibilities 29. In some instances, more than one level of environmental regulatory authorities provincial, prefectural (municipal) conducted on-site inspections of the same facility. Multiple Agency Jurisdictions 30. For offshore developments, multiagency jurisdictional issues and overlaps were identified as concerns. When components of offshore developments (such as a pipeline or processing facilities) come onshore, the jurisdiction for these project components changes. The onshore components of offshore projects require conducting separate environmental assessments. This results in one assessment process for the offshore and one for the onshore facilities. Different regulatory authorities administer these environmental assessment review processes. In addition, a number of other agencies also have some type of regulatory jurisdiction for marine or coastal environments and must be included in EIS reviews. Coordinating reviews under these circumstances is very challenging to enterprises attempting to acquire project approvals through multijurisdictional and complex regulatory processes associated with these types of developments. 31. Amendments to the "Marine Environmental Protection Law" promulgated on April 1, 2000, appear to consolidate onshore components of offshore oil and gas exploration and development with the State Marine Administration. However, environmental issues associated with the onshore anciliary facilities associated with offshore developments (such as pipelines and production facilities) must still be submitted to SEPA for review and approval. Standard Setting for Petroleum Developments 32. Several participants observed that regulatory agencies (primarily SEPA) did not have sufficient resources to develop strong technical expertise in petroleum development issues. Consequently, sometimes standards were set or regulatory changes made that were difficult or impossible for SOEs to comply with. 41 33. A very limited review of ambient air quality standards (total suspended particles, SO2, NOx, CO, and ozone) and surface water (pH, chemical oxygen demand, biological oxygen demand, and petroleum) was conducted. The standards reviewed were abstracted from a 1994 report.13 The mission was unable to confirm that these standards are currently in effect. Moreover, the system in China of creating differing ambient concentration and pollutant discharge standards (air and water), depending on the nature of the receiving environment, makes it difficult to directly compare standards with those typically used internationally. Because EPBs set more stringent local standards, it cannot be assumed that the 1994 national standards reviewed by the author would be those that would apply to petroleum enterprise activities. 34. A more detailed comparison of standards should be undertaken by selecting a sample of petroleum activities and facilities and directly comparing the applicable ambient and discharge standards with similar facilities in other regulatory jurisdictions. This analysis would enable a more meaningful comparison between China's environmental standards applicable to oil and gas development, and other internationally recognized standards. Implementation of Environmental Standards and Policies at the Local Level 35. Interviews with SEPA, SAPCI, and oil and gas companies suggest that the issue of implementation (inspection and monitoring for compliance with discharge standards and operating requirements) by local EPBs is the most important one facing achieving government environmental policy objectives. The local conflict and pressures to enhance local employment and economic development and the complexity and vagueness of standards in legislation leads to a situation where negotiated resolutions are sometimes achieved outside of strict compliance to environmental regulatory requirements. 36. The oil and gas sector is characterized by a large number of construction projects, including well drilling (for example, in 1998, CNCP drilled more than 8,000 wells), pipelines, and field production facilities, such as oil batteries, dehydration facilities, and pipeline tie-ins. The large number of projects and their geographically disparate locations make effective inspection and monitoring activities a challenge for regulators. Large processing facilities (refineries, chemical plants, natural gas processing facilities) that are amenable to more frequent monitoring and inspection are important sources of local employment and taxation. It would appear that the reporting relationship of EPBs to local communities creates significant pressures to avoid enforcement actions that would result in reduced operating capacity or closure of these facilities because of the associated employment and taxation impacts to local communities. 13DHV Consultants BV and CH2M HILL International LTD. and COPIA Beijing. 28 Nov. 1994. Hubei Urban Environmental Project Industrial Pollution Control Component, "Action Plan and Feasibility Assistance", Phase 1, Volume I, Main Report 42 Recommendations 37. It is recommended that the working group include environmental, worker and public safety, and technical regulation as part of the regulatory responsibilities incorporated in the creation of new, modern regulatory frameworks for the upstream and downstream petroleum sectors. 38. The new upstream and downstream regulatory agencies have the following responsibilities: · environmental, worker, and public safety; · responsibility for resource conservation through sound reservoir management techniques; · technical standards for accepted petroleum operating and engineering design; · data collection and archiving; and · environmental and technical review of all applications (with the exception of large projects that might have national environmental or social impact considerations) for onshore and offshore projects and associated infrastructure. 39. These upstream and downstream regulatory agencies have the authority to convene inquiries for decision making on projects or for the review of operational policy issues. 40. Funding should be derived for operating these new regulatory agencies through a levy on oil and gas production or throughput, as well as on direct fees for services rendered. 41. The new regulators should be established as a national agencies with regional offices reporting to and funded by the national central agency offices. Rationale for Consolidating Upstream and Downstream Regulatory Authorities 42. Objectives of regulatory reform in China's petroleum industry should include enhancing the effectiveness of the current regulatory system. Creation of a petroleum regulator that broadly consolidates environmental, technical, fiscal, economic, and mineral administrative responsibilities creates an opportunity to improve the sector's environmental performance and enhance programs for worker and public safety. 43. By establishing a state-level regulatory organization with regional offices and agencies reporting to and being fully funded by the state central headquarters, a more consistent set of regulatory review processes and technical and environmental standards could be developed and implemented. Regional offices reporting to the central office could be expected to conduct and apply consistent regulatory compliance monitoring and enforcement actions. Establishing a consistent set of environmental standards and applying them uniformly to all enterprises with petroleum-related operations is one of the key aspects of creating a level playing field and ensuring that all participants compete equally. 43 44. Effective and efficient exercise of environmental, worker and public safety regulatory responsibilities requires development of strong technical knowledge of engineering design issues, construction practices, operating problems, and other factors that may lead to future environmental and safety problems. Consolidating these technical and environmental assessment capabilities in the creation of an upstream and downstream regulator is consistent with regulatory trends toward creation of "one window" regulatory agencies. The "one window" regulatory approach provides important advantages over regulatory structures where authorities and responsibilities are dispersed among many government departments or agencies with various approval or regulating functions. 45. Consolidating environmental, public, and worker safety regulatory authorities and responsibilities (along with mineral resources, fiscal, and economic regulatory functions) allows the regulator to create a more focused organizational mandate and administrative structure. A comprehensive structure enables the regulator to deliver a higher level of regulatory service to clients while requiring fewer human and financial resources. A focused "one window" regulatory mandate facilitates the development of a technically sophisticated regulatory workforce. This engineering, environmental, and operating expertise can be engaged to support a variety of other regulatory functions. 46. A technically competent regulator is better able to translate the government's health, safety, and environmental policy goals into standards, regulations, and inspection processes to ensure their implementation throughout China's petroleum industry (onshore or offshore). Upstream and downstream petroleum regulators could be most effectively organized with a strong "head office" and "regional offices" located in regions where petroleum resources are being developed. Regional offices should be funded fully by the central office so that no conflict of interest occurs in the implementation of enforcement of environmental, public safety, or worker safety mandates. This structure is necessary to ensure that the regulatory organization is not unduly influenced by local employment concerns or taxation issues where enforcement actions could result in the curtailment or shutdown of facilities that are not able to meet required operating standards. Further Studies and Next Steps 47. The current environmental regulatory structure for petroleum development in China is very complex. The implementation of more modern regulatory structures will require a number of further studies and initiatives as part of this transition process: A. Inventory existing technical and environmental legislation. B. Create a current regulatory roadmap. C. Draft legislation and regulations. D. Develop a regulatory business process design. E. Develop an organizational design. 44 A. Inventory Existing Technical and Environmental Legislation 48. Compile an inventory of environmental and safety legislation, policy, guidelines, and standards administered by various Chinese government agencies overseeing petroleum development (onshore and offshore). Areas of overlapping, conflicting, or unclear jurisdictional responsibilities should be identified. B. Create a Current Regulatory Roadmap 49. Prepare a regulatory roadmap that describes and documents the existing processes for environmental assessment and licensing, standard setting, establishment of worker safety standards, monitoring, enforcement, and technical engineering. Areas of overlapping jurisdictional responsibilities and gaps should be highlighted. C. Draft Legislation and Regulations 50. New upstream and downstream regulatory responsibilities will involve the development and adoption of new legislation by the government. Specific HSE and technical regulatory responsibilities should be included in this legislation (as determined by the government). Legislative drafting instructions should be prepared by a working group of technically competent representatives from appropriate government agencies, enterprises (SOEs, IOCs) and potentially, environmental NGOs. 51. Following the preparation of new legislation, drafting of HSE and technical regulations should be initiated. Regulations drafting should be done in reference to the legislative gaps and overlaps identified in the initial legal review (task 1). A review of legislation and regulation used by other internationally recognized "one window" regulatory agencies should be used to complete this task. D. Develop a Regulatory Business Process Design 52. Having defined the goals, objectives, and expected outcomes through legislative and regulatory drafting, regulatory business processes to achieve these objectives can be developed. E. Develop an Organizational Design 53. Following the design of specific business processes, detailed organizational design, skill requirements, and staffing issues associated with delivering the HSE and technical regulatory functions would be completed. These business processes may currently be delivered by other agencies (identified in steps A and B). In these instances, personnel from these organizations may be able to relocate to the new regulatory organizational structures created to regulate the upstream and downstream petroleum industries. 45 Annex 7: International Cases of Structural and Regulatory Reform 1. The working group asked the Bank to provide international examples of oil and gas sector reform and regulation. This annex includes experience from six countries Argentina, Brazil, Bolivia, Canada, Poland, UK. The working group, however asked for more in depth information about oil and gas sector reform and regulation and background information about the situation in different countries leading up to the reform process. The Bank has provided the Working group with the following reports for background information and in depth studies: Specific Country Experience Canada--Structural Reforms Succeeds after State Management of the Oil and Gas Economy Is Abandoned 2. State Management: From 1973 onwards, Canada pursued policies directed towards energy self-sufficiency, tried to separate itself from international markets, adopted a "national" pricing policy and discriminated against foreign investment. Heavy new taxes were placed on producers. The prices of oil and gas in almost all transactions were regulated. Controlled prices encouraged consumption and discouraged production. Export prices were regulated at above-market levels. Wastefully uneconomic flows of oil were established across the country. 3. The results were disastrous: oil and gas production fell; oil exports were almost eliminated; export gas markets were badly damaged; industry investment slowed; development projects were abandoned; foreign companies sold out and left the country; and political relations between producing and consuming regions and interests became tense. 4. Structural Reforms: In 1984 a new government decided to introduce market-oriented policies across the sector, taxes were reduced and regulators took account of these policies in their decisions. Despite a deteriorating international pricing environment, investment flowed back into the industry, markets improved and producer-consumer tensions were eliminated. Regulation now is "light-handed" and oriented towards facilitating market solutions. Oil output is up 30% and the country is a large net exporter. Gas production has more than doubled, exports have nearly quadrupled and Canada is the world's second largest exporter. Oil and gas projects, abandoned in the 80's, are alive again. And domestic consumer prices of oil and gas are among the lowest in the world. 46 Privatization in Bolivia 5. Before privatization of Bolivia's state-owned oil and gas company, YPFB, the company's production was gradually declining, the sales price for its gas exports to Argentina was dropping, and its exploration effort was declining in intensity. Moreover, YPFB was being financially squeezed by overtaxing, and the government was interfering in its day-to-day operations. Morale in the company was low. 6. This was the context in which the government decided to undertake reform. Its objectives were to redefine its role in the sector by irreversibly transferring ownership of the YPFB companies to the private sector and adult citizens; maximize private investment in the hydrocarbon sector; maximize the value of shares before privatization; enhance competition, promote efficiency, and further deregulation; protect consumers and the environment through regulation; and strengthen its policymaking capacity. 7. After extensive reviews of institutional options, the government decided to establish two exploration and production companies, and a pipeline company to operate all pipelines. The "residual" company remains in state hands. It contracts for services (such as drilling and seismic analyses), refines and distributes petroleum products, enters into concession contracts with private companies, and functions as natural gas aggregator to ensure fulfillment of the gas export contract with Brazil. A regulatory agency has been set up for both the upstream and the downstream sector. 8. In 1997 the government privatized the two exploration and production companies and the pipeline company. Some 25 companies participated in the bidding, and the three winning bids exceeded US$800 million. 47 Argentina--Regulation as State Industries Have Been Privatized 9. Argentina is the most developed and liberalized gas market in Latin America and one of the most developed in the world. In 1996, there were 5.2 million consumers (including 4.998 million residential) consuming 26.9 billion cubic meters. 10. In the 1980s the State controlled most of the economy. In 1989, 117 state owned enterprises accounted for about 50% of GNP, and 30% of them were subsidized by the state. By the end of 1994, most of these had been privatized and the total value of the privatized companies reached $26.9 billion. Until privatization in late 1992, the entire oil and gas industry was state owned. Upstream oil and gas exploration and production was under the control of the state company Yacimientos Petroleos Fiscales (YPF) and natural gas transportation and distribution was under the control of another state company, a subsidiary of YPF, Gas del Estado (GdE). 11. In late 1992 the entire gas network was restructured into two transportation companies (one for the north and one for the south) and eight distribution companies, which were then privatized. Foreign companies were invited to tender to buy these companies in joint ventures with local companies. There were strict rules preventing investors gaining ownership of both transportation and distribution companies or of more than one distribution company in each group. This led to a competitive market with a wide range of foreign investors who brought much-needed investment into the Argentine gas industry. The main foreign ownership in the Argentine gas industry (all in partnership with local Argentine companies) following privatization is as follows: Transportation · Transportadora de Gas del Norte (TGN, northern transport system)--TransCanada PipeLines, Canada; · Transportadora de Gas del Sur (southern transport company)--Enron, USA. Distribution · Metrogas (central Buenos Aires)--British Gas, UK; · Gas Natural BAN (north Buenos Aires)--Gas Natural of Spain; · Camuzzi Gas Pampeana (south Buenos Aires and Buenos Aires province)--Camuzzi (Italian gas distribution company). 12. The Natural Gas Act of 1992 is the natural gas regulatory framework. The intention is to encourage competition in all sectors of the gas industry but it recognizes that this is difficult to achieve at the transportation and distribution stages, and so regulation is needed. There is an open access regime, the state is excluded from providing services and the only private companies may transport and distribute gas. The Gas Act also set the conditions for gas exports and imports and the creation of the Natural Gas Regulatory Entity (Enargas). The government's stated objective is for a light handed regulatory regime with minimal intervention in normal commercial operations. Prices are set according to the "RPI minus X" system and reviewed every five years by Enargas.* Distribution companies may adjust their prices automatically if there is a change in inflation, the price of gas, and the transportation charge or in the tax regime. It is important to note that restructuring, privatization and the establishment of modern regulation took place simultaneously. This meant that investors knew in advance the rules that would govern their operations in the country. *In "RPI minus X", prices are escalated by the retail price index (RPI) minus an efficiency factor ("X") prescribed periodically by the regulator. 48 Legal Frameworks for the Gas Industry 13. In Brazil the primary law regulating the gas sector is the 1997 Hydrocarbon Law, intended to dismantle the monopoly of Petrobras in oil and gas activities. The law has broad coverage, defining the conditions for exploration and development concessions for oil and gas, refining and transport of petroleum products, and the import and transport of natural gas. The law obligates energy enterprises to provide negotiated third-party access to oil and gas pipelines, establishes the Hydrocarbon Sector Regulatory Agency (ANP) to oversee the introduction of competition, and stipulates that the prices of petroleum products and natural gas must be freed within three years after its passage. The ANP has been formed but is not yet fully staffed or functional, and the body of regulation under which the energy sector will function is being formulated. The distribution segment, however, is covered by the Concession Law for Public Services of 1995, which requires that all concessions for public services be awarded through competitive bidding. Brazil has also separate regulatory apparatus for distribution at level of each state. 14. In Poland two key energy acts regulate activities in the gas sector. The Geological and Mining Law of 1994 sets out the principles and procedures for granting concessions for oil and gas exploration and production. And the Energy Law of 1997 sets out the principles for developing competition in energy networks, including gas, heat, and electricity. The Energy Law obligates energy enterprises whose business is transmission and distribution to provide transmission services (open access) for domestic energy producers, establishes the Energy Sector Regulatory Agency (ERA) to oversee the development of competition in the sector, and states that natural gas tariffs will be fixed by the Ministry of Finance for up to two years after passage of the law, or until December 1999. Although the ERA has been formed, it is not yet fully functional, and the body of regulation that will govern the energy sector is being written. 49 How to Develop Gas Markets 15. To develop gas markets, the following factors are essential: · Competitive price at the wellhead. This is worked out by calculating back from the end user price necessary to compete against other fuels; · A large (anchor) customer, such as a power station to provide a large high-utilization load from the start. Taking environmental costs into account, gas is likely to be competitive against new coal fired power generations in some regions of China; · Considerable investment in distribution; · Proactive market strategies, and · Exclusivity for the gas distributor for a fixed period of time. Two examples of how gas distribution has been introduced and expanded Northern Ireland: How to Build a Gas Market 16. Northern Ireland is a part of the United Kingdom and has been without the benefit of natural gas until very recently. The development of the gas market started with the privatization of Ballylumford power station by British Gas in 1993. This was a 1,000 MW high sulphur fuel oil-burning plant and was environmentally damaging. British Gas converted it to natural gas, which was completed at the end of 1996. A pipeline company was set up (Premier Transco) to supply gas to the power station. On the back of the power plant sales, a distribution company was also set up (Phoenix Natural Gas). In both of these companies, British Gas (now BG plc) was the major developer but in both cases it brought in US investors for their particular expertise. 17. In 1997, Phoenix began to develop a gas distribution market within the Greater Belfast area (the main city of Northern Ireland). In order to encourage the development of the network, exclusivity was granted for fixed periods of time. There is exclusivity of transportation along the distribution network for 20 years (until 2016), and for selling gas to customers for eight years (to 2004), except that for large customers (those consuming over 75,000 therms, 204,000 cubic meters) the exclusivity is for just three years. Gas is bought under a 10 year long term contract. 18. Phoenix Natural Gas also had to provide a development plan, which is part of the license. This divides the area into 15 districts and gives a target for new connections in specified years of the plan. The network must be built such that 90% of customers can be easily connected. São Paulo, Brazil: How to Build a Gas Market 50 19. Comgás distributes around 1.2 bcm/year of natural gas to 250,000 residential and several hundred industrial customers in São Paulo, Brazil. Demand is forecast to grow dramatically, by an extra 2.9 bcm/year over the next few years. In 1997, the local State government brought Shell in as a strategic investor with a 20% stake. In 1999, Comgás was fully privatized and Shell and BG plc in consortium acquired the company in a public tender for just short of $1 billion (one of the highest priced utility sales in the world). 20. The privatization is in the form of a concession (BG and Shell have the right to operate the company for a time after which it reverts to the State) for 30 years. There is complete exclusivity on the pipeline network for the whole 30-year period, also for sales to residential and commercial customers. For industrial and power generation customers (large users), there is exclusivity of sales for 12 years. Comgás is given tough targets for laying distribution pipes each year. 21. The price to end users is a combination of the pass through of gas costs and transportation charges (that is the charge for transporting gas from the international source in Bolivia). These two elements are bought as a bundled service at the City Gate from Petrobras (the Brazilian Federal state monopoly upstream oil and gas and transportation company) under a long- term contract. Comgás may contract for additional gas supplies from other producers. Great Britain--Regulation as State Industries Have Been Privatized 22. Great Britain is totally self-sufficient in gas and consumed 85.8 billion cubic meters in 1997. After the end of World War 2, many privately owned utility companies were nationalized and brought under direct state control. The intention of this was to protect individuals from exploitation, either on safety or price grounds. It was believed that the gas industry was a natural monopoly and that therefore the public interest would be better served by having such industries in public rather than private hands. 23. The Gas Act of 1948 brought together and nationalized the 1,046 private and municipal gas companies then operating in Great Britain. This resulted in the creation of 12 Regional Gas Boards and the formation of the Gas Council. The newly formed Regional Gas Boards operated as separate statutory bodies and controlled everything related to gas supply. The gas supplied was initially "town gas", but after the award of exploration licenses under the provisions of the Continental Shelf Act of 1964, substantial reserves of natural gas were found in the North Sea. 51 24. Following the decision to use natural rather than town gas, all gas appliances throughout Great Britain had to be converted to use natural gas. Additional gas terminals also had to be built on the East coast and a high- pressure gas transportation system had to be constructed. The gas industry structure also had to be reorganized, so the Gas Act of 1972 renamed the Gas Council as British Gas Corporation and this then assumed control of the 12 Regional Gas Boards. 25. British Gas was privatized by public sale in December 1986 and sale proceeds were £7.9 billion (approximately $13 billion). British Gas was sold as a vertically integrated company and the industry was later restructured, mostly during the 1990s. The restructuring process was a very painful one for the company and its employees. It involved several referrals to the Monopolies and Mergers Commission (the government antimonopoly organization), a new Gas Act (in 1995) and the eventual division of British Gas into two completely separate listed companies (BG plc owning the transportation network and international assets, and Centrica with the right to supply gas to customers). 26. The current structure of the gas industry consists of gas producers (over 100), gas shippers and gas suppliers (about 40) and open access gas transporters (virtually the whole transportation and distribution network is owned by BG Transco, although there are six other very small local distribution companies). 27. Gas prices are made up of three elements: the production cost, the transportation cost and the tariff price. The last two are regulated. The tariff price is price capped according to the RPI minus X formula. Centrica had an exclusivity of supply to those customers consuming fewer than 2,500 therms a year but from 1998, competition was extended to all customers. This makes the UK the most liberalized and competitive gas market in the world (the same also applies to electricity). In contrast to the Argentinean case above, the British authorities made the mistake of restructuring after privatization, a painful process that affected investor confidence.