Red gold: the legal framework governing foreign investments in China's oil industry.

• Author: Zhong, Jackie

1. INTRODUCTION II. BACKGROUND A. A Brief Look at China's Oil Industry B. A Brief Look at Foreign Investments in China III. A CLOSER LOOK AT FOREIGN INVESTMENTS IN CHINESE OIL A. Oil Ownership and Upstream Production B. Petroleum-Related Laws and Regulations C. Laws and Regulations Governing Foreign Investment D. Implementing the Mineral Resources Law E. When Investing in the Chinese Oil Market F. Dispute Resolution G. A Brief Discussion of Taxes and Fees H. Guarding Against Corruption IV. CONCLUSION "So valuable is black gold to our very way of life that wars have been waged for it ..."

   --BLACK GOLD: THE STORY OF OIL IN OUR LIVES--

1. INTRODUCTION

   China's economic ascension began with Deng Xiaoping's rise to power in 1979. (1) At first, China remained self-sufficient in oil. (2) However, as the country's own oil supply became outstripped by its economic boom, China eventually became a net oil importer. (3) By late 2013, China had become the world's biggest importer of oil, edging out the United States. (4) Even though the United States uses approximately 7.7 million more barrels of oil per day than China, the United States is increasingly able to support its own oil demand due to domestic hydraulic fracturing, or "fracking." (5) Such an approach is more difficult in China due to complicated geology and high production costs. (6) Because of this, the Chinese government has begun to realize that it cannot develop an efficient oil sector without bringing in foreign investment and new technology. (7)

   Deputy Director of the National Energy Administration (NEA), Liu Qi, said at the First Energy International Investment Cooperation Forum held in Beijing in 2012 that China encourages foreign investors to carry out petroleum exploration and development in the country. (8) For a prospective foreign investor, successfully investing in China's oil market would require due diligence and consummate knowledge of its laws and regulations regarding petroleum and foreign investment.

2. BACKGROUND

   1. A Brief Look at China's Oil Industry

      When China began reforming its economy in the late 1970s, the country focused on advanced technology as the pathway to economic success. (9) Deng Xiaoping said, "It is becoming increasingly clear that science and technology are of tremendous significance as productive forces." (10) With this in mind, China sent scientists and engineers to other countries to study advanced technologies. (11) China also began to stress organizational innovation in reforming large firms in strategic sectors such as oil. (12)

      During the course of two decades, government ministries slowly evolved into large state-owned enterprises. (13) In the late 1990s, China began restructuring and reforming these enterprises. (14) This included major state-owned oil companies such as PetroChina, Sinopec, and the China National offshore oil Corporation (CNOOC). (15) The structure of these modern corporations was established with the help of international consultants and investment bankers. (16)

      The oil industry is a pillar of the Chinese economy, (17) and the country's state-owned oil companies play a large role. (18) China National Petroleum Corporation (CNPC) is China's largest oil and gas producer and supplier. (19) CNPC is also the sponsor and controlling shareholder of PetroChina, the fourth largest company in the world in terms of market capitalization as of 2015. (20) Its competitor, Sinopec, also an oil and gas producer, sits at number two on the list. (21) Rounding out the list of the "big three" Chinese oil companies is CNOOC, which is the largest producer of offshore crude oil and natural gas in China. (22)

      China's consistent growth in GDP and rapid urbanization has led to increasing demands for oil. (23) With a stagnant domestic oil industry, China has looked abroad to fulfill its oil needs. (24) The three major Chinese oil companies, along with others, have been heavily investing in overseas oil fields: CNPC/PetroChina ventures in Sudan and Ecuador, Sinopec in Azerbaijan and Saudi Arabia, and CNOOC in Indonesia. (25) However, few significant deals have worked out successfully. (26)

      The Chinese government has realized that reliance on imports diminishes the country's independence, especially when so many of its costly energy ventures are tied up in the Middle East and Africa, where political turmoil threatens regional stability. (27) As a consequence, a high priority for Beijing is to develop more domestic energy resources. (28)

      Part of the solution to China's increasing energy demand may be its oil shale reserves. (29) Chinese oil shale resources amount to 720 billion tons, located in 80 deposits of 47 oil shale basins. (30) This adds up to 48 billion tons of shale oil. (31) Proven oil shale reserves comprise about 36 billion tons. (32) There is even speculation that China's actual resource may exceed the oil shale reserves in the United States. (33) According to China's NEA data, these oil shale reserves can produce 10 million tons of oil annually. (34) Oil shale may turn out to be crucial in safeguarding China's energy security. (35)

      In the United States, the fracking revolution opened up the possibility of oil production in regions previously thought to be inaccessible, such as the flatlands of Texas, North Dakota, and Pennsylvania. (36) Much of China's shale activity is "locked in mountainous regions in western China." (37) Despite these geographical differences, China has set its sights on U.S. firms for their advanced fracking technology to help unlock the country's shale wealth. (38) In 2010, CNOOC joined in a venture with Chesapeake Energy, a U.S. shale gas leader. (39) In January of 2012, Sinopec bought a one-third stake in several new ventures of shale gas pioneer Devon Energy for $900 million. (40) Shell has also signed China's first production sharing contract for shale gas and is planning to build a $12.6 billion refinery and petrochemical complex. (41) This could potentially become the single largest foreign direct investment ("FDI") in China's history. (42)

      With Beijing intent on becoming more energy independent, as the United States has with its fracking revolution, foreign investments in the Chinese oil industry are bound to increase.

   2. A Brief Look at Foreign Investments in China

      For almost thirty years after the Communist Party came to power in 1949, China shunned direct participation by foreign capitalist entities in the country's economy. (43) When Deng Xiaoping implemented the open-door policy in the late 1970s, the country had no legal framework for foreign investment activity. (44) However, during the years of 1979 to 1985, China promulgated more than fifty laws and regulations relating to foreign investment. (45) This new regulatory scheme included regulations governing joint development arrangements, (46) joint venture laws regarding direct equity investments, (47) and tax laws providing for sale of products from joint ventures. (48)

      Likewise, there were many updates to the regulatory framework related to the exploration and development of petroleum resources in China. (49) These additions included petroleum regulations, model contracts, tax rules, and special import tax and customs provisions. (50)

      China has been negotiating bilateral investment treaties ("BITs") since the late 1990s. (51) BITs are a very important legal regime that govern a country's FDIs. (52) They protect investments made in foreign countries by setting substantive rules that govern the host state's treatment of the investment and establishing dispute resolution mechanisms in case there is a violation. (53)

      China currently has BITs with 130 countries. (54) However, the United States is not on this list. (55) China is currently in negotiations with both the United States and the European Union to establish a BIT. (56) However, U.S. Secretary of the Treasury, Jacob Lew, one of the brains behind the talks, estimates that a deal is still at least two years away. (57)

      Without a BIT as an anchor, potential foreign investors will have to look at the applicable laws and regulations of China in order to gauge the security of their investments. (58) However, the Chinese legal framework is a maze of unpredictable obstacles, overbearing government supervision, conflicting laws, and legislative loopholes. (59) In order to attract more foreign investment, especially in long-term ventures that oil and gas projects so often are, the Chinese government must eliminate conflicting regulations, create more monetary incentives for foreign enterprises, and implement clearer laws so that less is left up to the judgment of state agencies. (60) Most importantly, the Chinese government should de-monopolize the domestic petroleum industry. (61)

3. A CLOSER LOOK AT FOREIGN INVESTMENTS IN CHINESE OIL

   The Chinese state-owned oil companies seem to prefer production sharing agreements for energy exploration. (62) CNPC and Shell signed a production sharing contract for shale gas exploration in 2012. (63) On July 16, 2013, CNOOC signed its 200th foreign oil production sharing contract with British Petroleum. (64)

   Production sharing agreements have been long-used in international petroleum transactions. (65) Historically, the classic structure was a concession by the host government. (66) The foreign investor would pay a mixture of up-front fees, a royalty based on the amount and value of the resource extracted, and taxes on its revenues and profits, as well as fees for various services provided by the government. (67) The international oil company owned the resource. (68) During the first half of the nineteenth century, most energy projects in the Middle East and Latin America were concessions obtained by an international oil company. (69)

   However, during the second half of the nineteenth century, things changed. (70) National governments increasingly resisted the idea of foreign ownership of its natural resources. (71) From this revolution...