China: A Brief Analysis Of Shale Gas Industry Policies

I. Basic Policies

Upon approval by the State Council, on December 3rd, 2011, the Ministry of Land and Resources ("MLR") issued Public Announcement on Newly Discovered Minerals (Public Announcement of MLR, [2011] No. 30), explicitly categorizing shale gas as the 172nd new mineral. According to Procedures for Administration of Registration of Exploitation of Mineral Resources, to obtain an oil or natural gas exploitation license, the applicant shall submit the approval documents by the State Council authorizing the establishment of an oil company or approving oil or natural gas exploitation, which actually resulted in the monopoly positions in the upstream oil and gas field of those few state-owned oil companies established as approved by the State Council, such as CNPC, Sinopec, CNOOC and Yanchang Petroleum. Being categorized as an independent mineral resource as it is different from conventional natural gas means that shale gas resource will be administered by MLR as an independent mineral with independent investment policies. Therefore, various investors will be introduced to the shale gas industry thus breaking the monopoly by those few state-owned oil companies to the upstream oil and gas resources.

On December 24th, 2011, the National Development and Reform Commission and the Ministry of Commerce jointly issued Catalogue of Industries for Guiding Foreign Investment (2011 Revision), wherein, "exploration and development of unconventional natural gas such as shale gas (sino-foreign equity or contract joint ventures only)" is listed as item 9 of the mining industry under the catalogue of the encouraged industries for foreign investment.

On March 16th, 2012, the National Energy Administration issued Shale Gas Development Plan (2011-2015) (hereinafter "Plan"). In order to encourage the development of the shale gas industry, the Plan mapped out the following preferential policies: adopt market price for shale gas producer price; reduce shale gas exploration and exploitation royalties in accordance with related regulations; with priority given to review and grant land use right for shale gas project; in order to encourage sino-foreign cooperation, the Plan also raised that for encouraged industries for foreign investment such as shale gas exploration and exploitation, importing self-use equipment (including technology along with the equipment) not domically available is eligible for exemption of custom duties according to related regulations. The above mentioned preferential policies are gradually implemented with supporting regulations.

II. Taxation Policy

On March 21st, 2012, the General Office of MLR issued Notice on Properly Carrying out the Work of Levying the Compensation Fees on Sino-Foreign Cooperative Exploitation of Petroleum Resources (Guo Tu Zi Ting Fa [2012] No. 14) (hereinafter "Notice No.14"), requiring that sino-foreign cooperative exploitation of onshore/offshore petroleum resources within the territories and sea areas under the jurisdiction of the People's Republic of China shall be subject to mineral resources compensation fees. "Petroleum resources" in Notice No. 14 explicitly refer to conventional petroleum, natural gas as well as non-conventional petroleum and gas resources such as coal-bed gas, etc. Shale gas as a non-conventional gas resource is also subject to mineral resource compensatory fee. Notice No. 14 also clarifies that legally concluded contracts on sino-foreign cooperative exploitation of onshore/offshore petroleum resources prior to November 1st, 2011, within the agreed term of the contracts, shall continue to be subject to mining royalties in accordance with the then effective state regulation. Prior to the issuance of the Notice No. 14, according to Reply Letter on Confirmation that No Double Assessment of Mineral Resources Compensation Fees on Exploitation of Offshore Petroleum Resources in Sea Area of China in the Event of Mining Royalties Have Been Levied from the former Ministry of Geology and Mineral Resources, sino-foreign cooperative exploitation of petroleum resources is subject to mining royalties as provided in Regulation on Levy of Mining Royalties for Exploitation of Offshore Petroleum Resources and The temporary Regulation on Levy of Mining Royalties for Sino-foreign Cooperative Exploitation of Onshore Petroleum Resources, yet not subject to mineral resources compensation fees. Accordingly, contracts on sino-foreign cooperative exploitation of onshore/offshore petroleum resources (including shale gas) concluded after November 1st, 2011 shall be subject to mineral resources compensation fees instead of mining royalties. Mineral resources compensation fees shall be calculated and levied in proportion to the sales revenue of mineral products. The formula is:

Amount of mineral resources compensation fees to be levied = Sales revenue of mineral products ×Compensatory fee rate × Coefficient of mining extraction rate Wherein, Coefficient of mining extraction rate = Verified and determined mining extraction rate/Actual mining extraction rate The current applicable compensation fee rate of petroleum resources is 1%. The compensation fee on sino-foreign cooperative exploitation of onshore/offshore petroleum resources shall be subject to the "levy at the locality" policy, which could directly increase the revenue of local governments and enhance their enthusiasm in introducing foreign investment into exploitation of mineral resources.

On May 30th, 2013, the State Administration of Taxation (hereinafter "SAT") issued Announcement on Issues Concerning VAT Treatments Related to the Development of Coalbed Methane and Shale Gas by Oil and Gas Companies (SAT Announcement [2013] No.27) (hereinafter the "Announcement No. 27"), effective July 1, 2013. Announcement No. 27 clarifies that oil gas field enterprises engaging in coalbed methane and shale gas production, or provide production services for coalbed methane and shale gas production, are subject to VAT in accordance with the Circular on VAT Administration for Oil and Gas Field Enterprises (Cai Shui [2009] No.8)(hereinafter "Circular No.8"). Circular No.8 applies to enterprises engaging in production of crude oil and natural gas (including shale gas, as per Announcement No. 27), including new branches/subsidiaries established after the restructuring of CNPC, Sinopec, as well as original CNPC and Sinopec entities that continue to exist after the restructure and other oil and gas manufacture enterprises (hereinafter "oil and gas field enterprise"), but excludes those to which the 5% VAT rate approved by the State Council is applicable. General production services provided by oil and gas enterprises are subject to VAT at 17%. That is to say, general production services provided by oil and gas enterprises engaging in developing shale gas production or providing production services for shale gas production are subject to VAT at 17%.

In addition, Notice on Questions Related to Temporary Provisional Regulation Concerning Taxations including VAT, Consumption Tax and Business Tax Applicable to Enterprise with Foreign Investment and Foreign Enterprise by the State Council (Guo Fa [1994] No. 10)(hereinafter "Notice No. 10") regulates that crude oil and natural gas exploited from sino-foreign cooperative oil (gas) field are subject to VAT at 5% in kind. The State Administration of Taxation issued the Notice on Questions Concerning VAT Payment of Sino-Foreign Cooperative Exploitation of Oil and Gas (Guo Shui Fa [1994] No. 114), which further clarifies that oil and gas exploited from sino-foreign cooperative oil (gas) field and the proprietary offshore oil and gas fields of CNOOC shall be taxed in kind with VAT at 5%. According to the above mentioned regulations, the shale gas exploited by sino-foreign cooperation is subject to VAT at 5%.

Though no direct import-tax exemption policy upon shale gas has been promulgated, nevertheless, on August, 8th, 2012, the Ministry of Finance, the General Administration of Customs and SAT jointly issued Notice on Tax Exemption for Importing Goods upon Coalbed Methane Exploration and Development Program during the "Twelfth Five-Year Plan" Period (Cai Guan Shui [2011]No. 30), Notice on Tax Exemption for Importing Goods upon Petroleum/Natural Gas Exploitation in China's Certian Land Areas during the "Twelfth Five-Year Plan" Period (Cai Guan Shui [2011]No. 31) and Notice on Tax Exemption for Importing Goods upon Petroleum/Natural Gas Exploitation in China's Offshore Areas during the "Twelfth Five-Year Plan" Period (Cai Guan Shui [2011]No. 32), clarifying the tax exemption scale. The above-mentioned three notices, especially the one targeted on unconventional natural gas coalbed methane, with consideration of the preferential policies raised in the aforementioned plan, will play a very positive role on shale gas tax policy-making process.

III. Administration of Mining Rights Policy

On October 26th, 2012, MLR issued Notice on Strengthening the Exploration and Exploitation of Shale Gas and Relevant Supervision and Administration Work (Guo Tu Zi Fa [2012] No. 159) (hereinafter "Notice No. 159"), setting forth the requirements as to exploration and exploitation of shale gas in conventional oil and gas blocks. Notice No. 159 encouraged shale gas exploration and exploitation within conventional oil and gas blocks. Holders of oil and gas mining rights may explore and exploit shale gas within the area covered by their mining rights, provided that mining rights alteration procedure is properly processed or new mine category to be explored and exploited is added. For conventional oil and gas blocks with shale gas resource potential, in the event of mining rights holder gives up shale gas exploration, MLR may separately set up shale gas exploration right after proper demonstration. For oil and gas blocks with insufficient exploration investment and an unclear exploration future for conventional oil and gas resources but with a potential for shale gas resource, in the event of current mining rights holder gives up shale gas exploration, such right holder shall quit from such blocks and MLR may set up new shale gas exploration right as provided by law. Mining rights holders who have conducted shale gas exploration and exploitation within existing gas and oil blocks should promptly apply for mining right alteration or adding shale gas as a new subject of its mining rights. Considering the fact that a large number of blocks with shale gas resource potential overlap with current existing conventional oil and gas blocks held by the state-owned oil companies, implementation of Notice No. 159, which has set forth the basic principles for the administration of mining rights of such overlapped blocks, will undoubtedly result in release of more blocks with shale gas resource potential to the market.

IV. Subsidy Policy

On November 1st, 2012, the Ministry of Finance and the National Energy Administration jointly issued Notice on Introduction of Subsidy Policy for Development and Utilization of Shale Gas (Cai Jian [2012] No. 847) (hereinafter "Notice No. 847"), stating the conditions and the standard of the central government subsidy for shale gas development enterprises. The conditions for shale gas subsidy are set forth as (1) shale gas has already developed; (2) the enterprise has installed the metering equipment which can accurately measure the volume of the developed and utilized shale gas, and is able to provide the accurate data of the volume of the developed and utilized shale gas. The standard of the central government subsidy for shale gas from Year 2012 to 2015 is 0.4 yuan per cubic meter, which is as twice as the coalbed methane subsidy, and such standard may be adjusted based on the development of the shale gas industry. Notice No. 847 also provides that local governments may offer proper subsidy for shale gas development and utilization based on the local shale gas development and utilization condition. The specific standard and method of the subsidy will be regulated according to practical situation. Though no local subsidy policy for shale gas has been published so far, local subsidy will undoubtedly become a tool for local government to attract investment into the shale gas industry.

V. Open Tender Policy on Shale Gas Exploration Rights

So far MLR has carried out two rounds of open tender on shale gas exploration rights. The first round of shale gas exploration rights bidding, which was held in mid-June of 2011, was conducted in the form of invitational bidding; the invited bidders were CNPC, Sinopec, CNOOC, Yanchang Petroleum, CUCBM and Henan CBM, which are all state-owned enterprises, competing for only four subject blocks. Sinopec and Henan CBM each won the bidding for one block and the other two blocks were under bid.

MLR publicized Notice on the Second Open Tender for Shale Gas Exploration Rights ("Tender Notice") on its official website on September 10, 2012, providing for 20 blocks for bidders' competition; this Tender Notice marks the second round of bidding for shale gas exploration rights in China. The Notice requires that any bidder: (1) shall be a domestic enterprise or a Sino-foreign joint venture with Chinese parties as controlling shareholders, which is incorporated within China with its registered capital above RMB 300,000,000, having a good financial status and a sound financial and accounting system, and is capable of bearing civil liabilities independently; (2) shall be qualified for oil and natural gas exploration or for gas mineral exploration, or have established cooperation relationship with an enterprise or institution qualified for oil and natural gas exploration or for gas mineral exploration; and (3) shall be an independent legal entity, and shall not bid as a consortium. Compared with the first round of bidding, this second round has greatly reduced the threshold for bidders, which is no longer limited to state-owned bidders and is now also open to privately-run enterprises and certain Sino-foreign joint ventures.16 enterprises won the bidding and obtained 19 blocks exploration rights from the MLR second open tender, wherein, six central enterprise, eight local enterprises and two privately-run enterprises. The exploration term for the biding blocks is three years and these successful bidders shall achieve their proposed investment and working load during the course of the exploration.

VI. Conclusion

With the passage of time, the government is creating a favorable policy environment for the progress of shale gas industry. It is reported that the National Energy Administration has already prepared protocols on Shale Gas Industry Policy and Natural Gas Infrastructure Operation Management Method under review. As a whole, the shale gas industry development is still in its early stage and only a few shale gas exploration, exploitation, finance and tax policies exist. In the meantime, lack of capital investment and advanced technology also hinders enterprises engaging in this newly developed industry. Therefore, the healthy development of the shale gas industry hinges on how the state formulates related state policies and regulations and how enterprises achieve a well-established integration of capital investment and advanced technology.

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