China Enacts New Measures For Third-party Access Scheme.
Legal News & Analysis - Asia Pacific - China - Energy & Project Finance
7 June, 2019
On 24 May 2019, the new Measures for Regulation of Fair and Open Access to Oil and Gas Pipeline Facilities (Measures) were published by the National Development and Reform Commission (NDRC), the National Energy Administration (NEA), the Ministry of Housing and Urban-Rural development and State Administration for Market Regulation and entered into force on the same date.
It has been five years since China made its first attempt at establishing a third-party access regime for midstream oil and gas infrastructure with the Measures for Regulation of Fair and Open Access to Oil and Gas Pipeline Facilities (for Trial Implementation) (Trial Measures) published by NEA in 2014.
In this update, we briefly introduce the background and the third-party access scheme adopted in China and outline highlights of the Measures, together with the previous Trial Measures and our observations of the implication for China’s third party access regime.
China’s midstream oil and gas infrastructure ownership and operations have been dominated by state-owned enterprises (SOEs) which has hindered the market liberalization of the petroleum and energy supply chain (from upstream through to downstream). In 2014, China started a 5 year trial period for a third-party access scheme to provide other, non-SOE, third parties access to the midstream oil and gas infrastructure. Under the Trial Measures, pipeline and facility operators were to grant third parties access to their pipeline networks and associated facilities if there was surplus capacity. In the case of multiple third-party users, a non-discrimination principle should apply, but service contracts for open access should be awarded on “first come first served” basis.
However, on implementation of the Trial Measures a number of key issues arose which hindered its application and jeopardized the implementation of the open access scheme. One of the key issues was the lack of clear definition of “surplus capacity” and no official or independent mechanism or authority to determine what constituted “surplus capacity”. It was left to the operators to determine themselves whether there was “surplus capacity” and this resulted in little (and intermittent) surplus capacity being put on the market. In addition, the price to use this surplus capacity was to be determined by the pricing authorities of the Government which did not give appropriate pricing incentives for the market players and operators. As result, the five year period of the Trial Measures came to an end in February 2019 with only a limited number of facilities being opened for third party access.
In August 2018, NDRC issued a draft version of the Measures for public comment. This was followed by an announcement in March 2019 that a separate national pipeline network company is to be established. It is expected that CNPC, Sinopec and CNOOC will transfer their main pipeline assets into the national pipeline network company first. At later stage, the national pipeline network company will be open for public investors, including national investment funds and private investors, and to be publicly listed on stock exchanges. In addition, some of the SOEs have also started to explore options to open up their LNG receiving terminals and provide access rights to third parties.
On this basis, the newly enacted Measures are expected to provide a more integrated and detailed legal framework to support further development of a fair and open access regime in China in the next five years.
Highlights of the Measures
The Measures contain 42 articles divided into 8 chapters. We set out below the highlights of the Measures.
Scope of application
The Measures generally follow the Trial Measures in defining the scope of application, i.e. fair and open access to “Oil and Gas Pipeline Facilities” within China. “Oil and Gas Pipeline Facilities” means those facilities which comply with technical conditions and specifications, have completed relevant permitting, approvals or record-filing and obtained necessary operation permits – and include pipelines for crude oil, refined oil and natural gas and LNG receiving terminals. However, it is noted that certain categories of facilities are specifically excluded such as pipelines located in onshore or offshore oil and gas fields for production, pipelines located in production areas for refinery production, and urban gas facilities.
Operators of these Oil and Gas Pipeline Facilities (Operators) are obliged to grant third-party users “fair and open access” their facilities under the Measures. It is expected that the newly announced national pipeline network company will be one of the key Operators that are subject to the Measures.
Unlike the Trial Measures which splits third party users into two categories (i.e. “Upstream Users” and “Downstream Users”), a unified term of “Users” is used in the Measures which includes oil and gas production companies, trading companies, oil and gas marketing companies and large-scale end-users incorporated in China. However the Measures do not provide a definition of “large-scale” in this context.
General promotion for fair and open access
It is highlighted in the Measures that fair and open access to oil and gas pipeline facilities is encouraged and supported by these regulations. Some new principles and policies to support third party access rights are also provided in the Measures, including the encouragement of more investors to invest in, and develop, greenfield Oil and Gas Pipeline Facilities which are under planning stages; and that national and local oil and gas development plans are also to take into account, and encourage, interconnection between Oil and Gas Pipeline Facilities, the supply of resources and market demand and to provide support for the third-party access regime.
Operators are also obliged to provide convenient interconnection between Oil and Gas Pipeline Facilities and are not permitted to refuse to open its facilities for third party access merely because of any state monopoly in the purchase and marketing of petroleum products.
Conditions for fair and open access
Prior to finalization of oil and gas pipeline operation reform, Operators are to grant qualified Users access to their Oil and Gas Pipeline Facilities and offer transportation, storage, regasification, loading, unloading and transhipment services, provided that any “current service for current User” is not affected and that the Operator has “surplus capacity” to offer. Unfortunately, the Measures remain silent on what constitutes “qualified Users”, “current service for current User” and “surplus capacity”. On this basis it appears that Operator will still have the final say on how to allocate capacity in their Oil and Gas Pipeline Facilities.
However, as a step forward, a new set of disclosure requirements are promoted. Operators are now required to disclose more information to the public including basic information of their Oil and Gas Pipeline Facilities, surplus capacity, conditions for services, technical and pricing standards and process for applying for access rights. Information on current services provided is also to be disclosed and updated by Operators on quarterly basis subject to confidentiality obligations.
It is worth noting that Operators are required, by 5 December each year, to disclose the monthly surplus capacity of in the following year and update this information on a monthly basis throughout the year. Operators are even encouraged to disclose this information on a real-time basis. By comparison, under the previous regulations, Operators were only required to disclose this information upon request by users who have applied for access rights.
Metering and pricing requirements
According to the Measures, the Government is now also promoting new and more efficient measurement in metering of natural gas based on energy content (BTU) which is more typically used in global LNG trading business. This will help Users align their domestic metering with their international contracts and promote a more efficient process right through the supply chain from upstream source to downstream user. It is planned that the new metering system shall be established by end of May 2021. But this is expected to be a big challenge in practice as market players in downstream sectors currently adopt volumetric (cbm or cbft) measurements.
On the pricing side, the Measures provide for two sets of pricing mechanisms: (1) prices regulated or guided by the government (if required by relevant governmental policies); and (2) unregulated price (i.e. prices where the parties agree on the price based on market terms and conditions). Given that the national pipeline network company is to be established soon, there is speculation that the service provided by this company may adopt the first method of charging (regulated prices) while the Operators might be free to negotiate the price with Users (unregulated prices).
Compared to the Trial Measures which were silent on metering method and required that pricing shall be based on the transportation price set up by relevant authorities, industry players have noted that the Measures could provide more incentives for Operators to share capacity.
Process of fair and open access
Unlike the Trial Measures which only allows Users to apply for access directly with Operators, the Measures offer an additional way for Users to apply for access rights, namely that Operators are to publish notices for open services (i.e. spare capacity) first thus allowing Users to then consider and apply for access rights later. The Measures further provide that the results of any agreement for third party access rights are to be published to all applicants and copied to NEA or its local agencies. If applicants choose to apply directly, Operators shall give a response within 15 working days after receiving the application. This is expected to result in more transparent information and a more ‘level playing field’ for applicants.
Operators and Users shall enter into a service contract prior to implementation of open access rights. The service contract shall consist of clauses on service term, quantity, delivery point, price, quality, pressure, transportation route, examination and maintenance, metering, balancing and liabilities. “Use-or-pay” terms shall apply, wherein if Users fail to use the service capacity provided by Operator, they shall still be required to pay for the service in accordance with regulations and contracts.
The Measures do not impose strict or “hard” consequence for non-compliance by the Operators, such as financial penalties. The Measures only provide that the NEA may order rectification and give opinions in relation to penalties for responsible personnel, while the Operators may be punished in accordance with an energy industrial credit regime which is yet to be established.
If there are disputes arising from granting of open access rights, Users may approach NEA for “coordination” within 30 working days after receiving the response from Operators. For disputes arising from performance of service contract, Parties may approach NEA for “coordination” or mediation, or institute litigation or arbitration process directly. However, it is not clear how the coordination will be carried out as it appears that NEA will only help Users to open up discussions with Operators without other binding authority. From a practical perspective, it remains to be seen how effective the NEA will be in exercising its power to oversee and “regulate” the market with these powers.
In recent years, the Government has been seen to actively push forward the liberalisation of its oil and gas sector. In addition to encouraging more investors, in particular those private investors and foreign investors into the upstream business and establishment of the national oil and gas pipeline network company, the promulgation of the Measures represent new policies on encouragement and support for further opening up of the midstream oil and gas facilities.
However, there remains some vagueness and ambiguity on various aspects of the Measures and it remains to be seen how this third-party access scheme will be developed under the framework of the Measures in the near future.
For further information, please contact:
Hilary Lau, Partner, Herbert Smith Freehills