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Factbox: A tour of China's new oil and natural gas industry reform plan

Singapore — Beijing recently unveiled a long-expected oil and gas industry reform plan, which will serve as a guideline for future development of the sector.

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The Central Committee of the Communist Party of China and the State Council, or the cabinet, approved the plan, an abstract of which was published in the state-backed Xinhua news agency late Sunday.

"The details of the plan are sensitive, which is likely why it was only issued to central government authorities," said a source with a government-backed research institute.



As widely expected, the aim of the guideline is to reform the sprawling state-controlled sector and improve efficiency and energy security by better managing the roles of enterprise, market and government in the world's second-largest economy.

In China, the oil and gas industry remains dominated by state-owned oil giants, especially in the upstream sector, although independent companies have evolved in recent years.

"Market should play a decisive role in resource allocation and the government's role should be to safeguard national energy security, boost productivity and meet people's needs," Xinhua reported, citing the reform guideline.

The reform is also a key plank of the country's 13th Five-Year Plan for 2016-2020, Xinhua said.

The plan listed eight reform tasks covering upstream, oil and gas import management, refining, pipelines, products pricing mechanism, state-owned companies reform, storage, and environmental and safety management.

Some key points about the tasks and recent development are highlighted below:


UPSTREAM


Beijing is targeting to invite competition in upstream exploration and development by issuing tenders for blocks and strengthening the terms and conditions that a company must fulfill in order to retain a block.

The government will allow non-state-owned companies to apply for licenses to develop conventional projects.

Traditionally, the government allocated upstream blocks based on applications from the four state-owned companies -- PetroChina, CNOOC, Sinopec and Yanchang.

The government experimented with awarding blocks to independent companies in August 2015, when it offered six blocks in the western Xinjiang Uygur Autonomous Region and state-owned and independent companies were invited to bid for them.

Some independent companies even won blocks in this tender, but these were not the most promising acreage and development was further hit by low oil prices as well as their experience in upstream.

Meanwhile, earlier this year, PetroChina, Sinopec and CNOOC for the first time agreed to exit blocks that they had previously been awarded in the Xinjiang region, after failing to make significant progress on them.

This is a break from the norm when these companies held on to blocks even if they did little work on them. The government is planning to offer these blocks through the tender route.


IMPORT/EXPORT


The government plans to develop a system to more actively monitor crude imports by quota holders and state-owned companies and independent refiners.

This means that independent refiners, which began importing crude oil in 2015, will come under tighter scrutiny and supervision.

Under the plan, the supervision is expected cover all aspects of a refiner's operations, including whether or not a quota holder is selling quotas to other refineries and if they are adhering to all taxation regulations.

The authorities are also required to improve policy for oil product exports under the processing and general trade route, according to the plan.

This is important to the refining sector as state-owned oil companies recently resumed oil product exports under the general trade route after more than 10 years of suspension, while independent refineries are eager to restart product exports after they were denied export quotas late last year.

China allows oil product exports via two routes -- the processing trade route and the general trade route -- and issues separate quotas for the two.

Under the processing trade route, there are no applicable taxes on the product, but this way offers almost no flexibility to the exporter.

The exported product must be refined using imported crude oil; must come from a specific refinery which has won an export quota; and the seller of the crude oil must be the buyer of the oil product.

Under the general trade route, state-owned trading companies are free to export oil products from within their refining system or even external, irrespective of their production from domestic or imported crudes.

Until recently, oil companies using the general trade route needed to pay taxes, including VAT and consumption tax, to the government.

But in November 2016, Beijing allowed a rebate on VAT and consumption tax on products exported via this method, opening up this route.


OIL AND GAS PIPELINE


Beijing aims to separate the oil and gas pipeline business from the state-owned oil giants in order to break their monopoly and improve transportation efficiency.

This task is already under progress as the oil giants have set up pipeline companies in anticipation of the separation.


REFINING


The government is aiming to set higher standards on product quality, operational efficiency, environmental protection and safety in the refining sector. The aim is also to invite more competition.

Beijing plans to better control new entrants in the refining sector and put in place a system to phase out old capacity as it tries to reduce excess capacity.


PRICING MECHANSIM


Beijing has been working on a market-oriented pricing mechanism for several years, but the pace of reform has slowed down recently as the retail market remains dominated by state-owned oil giants, with Sinopec and PetroChina controlling around 60%-70% of the market.

This makes it difficult for the country to meet the industry's expectation to have a purely market-driven domestic price. Therefore, the guidance price set by the NDRC is still the benchmark used by the domestic market.

Under the oil-product pricing mechanism that was introduced in March 2013, the guidance prices are adjusted every 10 working days in line with movements in international crude prices, unless the resulting price change is less than Yuan 50/mt. If this occurs, the adjustment is rolled over and included in the next price change.

The reform plan encourages the development of oil and gas trading platforms in order to generate a market price. However, the plan emphasized that the government has the right to control prices when there is excessive volatility.


STATE-OWNED COMPANIES' REFORM


The plan aims to improve competitiveness of the state-owned companies by diversifying shareholding, simplifying the management hierarchy and restructuring, including going in for mergers and acquisitions.

Progress is already underway in this sphere, with the planned listing of Sinopec's marketing business and a possible merger between Sinochem and ChemChina.


STORAGE


Beijing aims to secure oil supplies and develop a storage system with the involvement of both government and private enterprises.

Oil companies are required to store barrels not only for their daily operation, but also for the country's energy security.

This is already underway, with oil companies having built up significant commercial crude oil stocks in the last couple of years, driven by low oil prices, which can be requisitioned by the government when there are security needs.

--Oceana Zhou, oceana.zhou@spglobal.com
--Edited by Arnab Banerjee, arnab.banerjee@spglobal.com, and Mriganka Jaipuriyar, mriganka.jaipuriyar@spglobal.com