6 January, 2016
China is the world’s biggest generator and consumer of energy. Coal and hydroelectricity continue to be the primary sources for the generation of the country’s energy needs, making up 63% and 22% respectively. However, China is increasingly making efforts to diversify its energy sources, moving towards nuclear, renewable sources and natural gas in an effort to address environmental concerns and the prospect of diminishing supplies from more traditional sources such as coal and oil.
To a certain extent, this shift can be seen in the hard times and slew of bankruptcies that are being faced by China’s many teakettle refineries, which make up around 30% of the country’s refining capacity. In the absence of concrete data from the larger players, teakettles have often acted as a useful barometer for the domestic energy market.
As a consequence the regulatory landscape, both now and for the foreseeable future, is anchored in China’s ambitious economic restructuring agenda. Top priority is being placed on environmental goals and the deployment of cleaner energy.
When it comes to energy regulation in China the stakeholders are split into four categories. First, there is the long list of governmental authorities which heavily regulate the energy sector. There are then monopolistic state owned enterprises which dominate the market, private companies which are endeavouring to catch up and foreign companies that have had varying degrees of success.
This article provides a brief overview of China’s shifting energy landscape, looking in particular at the less traditional sources of energy that are likely to come to the fore over the coming years and the steps which legislators and regulators are taking to open up the country’s energy market and put these changes into effect.
The Regulators
Starting with the regulators, the main one is The Ministry of Land and Resources (the MLR), which is responsible for the supervision and administration of any exploration or exploitation of mineral resources. Crucially, the MLR has the authority to grant any licences required for exploration and production in China. It also plays a role in the examination and approval of energy blocks that might be open to foreign investment.
Other regulators include the National Development and Reform Commission (the NDRC), which produces and implements policies for the oil and gas sector and takes responsibility for approving certain investment projects. The National Energy Administration (the NEA) has a broad range of duties that range from drafting energy strategies and proposing reform advice to approving overall development plans for a specific oil or gas project. The Ministry of Commerce (or MOFCOM) was previously in charge of reviewing and approving any production sharing contracts (PSCs). However, recent changes have done away with the approvals process, and instead records must now be filed with MOFCOM.
Shale Gas
China is believed to have the world’s largest known shale gas reserves. It is estimated by the MLR that the reserves of shale gas in China amount to around 885 trillion cubic feet. At an even higher figure, the US Energy Information Administration puts China’s reserves at 1,275 trillion cubic feet, which is larger than the combined reserves of the USA and Canada.
China has therefore set ambitious targets in respect of shale gas. Under its current five year plan it intends to extract 6.5 BCM of shale gas per year in order to meet at least 10 per cent of the country’s energy demands with shale gas by the end of 2015. Under the blueprint for the next five year plan it has been proposed that the yearly output for shale gas should reach 30 BCM by the end of 2020.
To achieve these targets, China has accelerated the issuance of exploration licences for shale gas reserves. When it comes to the regulation of the shale gas industry, it generally follows the regime for conventional oil and gas. Both the licencing regime and the PSC regime apply to shale gas exploration and exploitation by foreign investors. Foreign companies can partner with Chinese companies holding an exploration licence for a shale gas block or they can establish a joint venture with a Chinese partner to bid for the licences directly.
The Foreign Investment Industrial Guidance Catalogue (2015), issued by the NDRC and MOFCOM, sets out ‘encouraged’, ‘restricted’ and ‘prohibited’ activities and sectors; and generally acts as an indicator of things to come. Projects that are encouraged benefit from simpler approval procedures and can also benefit from customs incentives. Whereas restricted activities and sectors must generally be approved at higher levels of government, which means that approvals can be harder to obtain. Sino-foreign joint venture cooperation in the exploration and development of shale gas is ‘encouraged’ under the latest Catalogue. This means that foreign investment in shale gas will receive certain tax and administrative benefits.
However, at the same time MOFCOM has issued a Notice on Development Plan for Shale Gas, which makes the additional requirement that foreign investors should first have expertise in the exploration and production of shale gas.
Aside from attempting to open up the shale gas market, the 2015 Catalogue also released more general restrictions on foreign investment in the energy sector. The construction and operation of power grids, for instance, has moved from the ‘restricted category’ to the ‘encouraged category’. In addition, the requirement to involve Chinese parties in the construction of power transmission equipment and the development of exploration and exploitation technology has been cancelled. This trend towards opening up the energy industry to private and foreign investors is in line with the major SOE ownership reform since 2013.
Renewable Energy Sources
China has had a dramatic response to climate change in recent years, and the State Council and the regulators have set some ambitious objectives. By way of an example, the NDRC had set mid and long term plans for renewable energy development, requiring that 10 per cent of total energy consumption should be sourced from renewable energy by 2010, and 15 per cent by 2020. The midterm target of 10 per cent by 2010 has been achieved.
At the end of 2014, the State Council released the Energy Development Strategy Action Plan for 2014 to 2020. The Plan lists the future strategies for an efficient, clean, safe and sustainable energy system. According to the Plan, the annual primary energy consumption is to be capped at an amount equivalent to 4.8 billion tonnes of standard coal by 2020. The Plan then sets goals on future energy sources, with at least 10 per cent of energy to be supplied by natural gas and at most 62 per cent from coal by 2020.
By way of some examples, the Chinese government has established a clean development mechanism fund to support construction and
industrial activities that strengthen the countries response to climate change since 2010. The construction and operation of power stations using renewable energy is now an ‘encouraged’ activity under the 2015 Foreign Investment Catalogue. Under the current power regime, the government sets higher feed-in tariffs (FITs) to encourage power generation from renewable energy.
Other incentives include favourable loans with financial discounts for renewable energy projects; tax incentives; surcharges collected from end-users, which are used to subsidise the difference between feed-in tariffs and the benchmark price for desulfurized coal generators, operations and maintenance for independent public power systems, and costs for connecting renewable energy generators to power grids; and subsidies for renewable energy development in areas such as new-energy vehicles, building-integrated solar photovoltaic systems, wind turbines and biomass power generation.
These reforms have been paying off with huge investments being made in renewable energy sources. In particular hydro-power, which already provides over 22% of the country’s power, wind, which makes up around 6% and solar power. Offshore wind power is now one of the main ambitions, and the country plans to construct 44 offshore wind farms by the end of 2016.
Nuclear
As a final point, the NDRC approved a nuclear project in March 2015 marking the official re-launch of nuclear projects in China. The State Council’s mid and long term development plan for Nuclear Power has set the target for installed nuclear power capacity of 58,000,000kW and 30,000,000kW to be under construction by 2020. The industry is expecting a large wave of investment into nuclear power in the near future.
Conclusions
The energy sector and the regulatory environment in China are changing fast. The development of green energy and the economic restructuring plan are having a profound influence on the domestic energy market. The demands of the various stakeholders are contributing to innovation in the industry, while also adding complexity to the reform process. With reforms in the regulatory regime and the restructuring of the market, it is vital to keep a close eye on energy regulation in China.
For further information, please contact:
Ik Wei Chong, Partner, Clyde & Co
ikwei.chong@clydeco.com
