China Imposes Mineral Resources Compensation Fee on Petroleum Contracts Signed After November 1, 2011

Oil and gas companies operating in the People’s Republic of China ("PRC") are well advised to stay alert to recent government charges and taxes levied in the country that may affect their return on investment from PRC petroleum projects. This Alert summarizes these recent developments, focusing particularly on the new Mineral Resources Compensation Fee ("Compensation Fee").

On September 30, 2011, the PRC State Council issued Decree No. 605 to launch the resource tax scheme. The resource tax is calculated as five percent to 10 percent of the sales revenue from crude oil and natural gas. Prior to this decree, petroleum projects were subject to a royalty scheme based on petroleum output.

Following the imposition of the resource tax, a new government charge has been announced. The Ministry of Land and Resources ("MOLAR") issued a Notice of Collection of Mineral Resources Compensation Fee of Sino-Foreign Petroleum Resources ("Notice") on March 31, 2012. The Notice imposes the Compensation Fee on petroleum contracts entered into on or after November 1, 2011. "Petroleum projects" will include conventional energy sources such as crude oil and natural gas as well as unconventional energy sources such as shale gas and coal bed methane. For petroleum projects, the Compensation Fee is assessed as one percent of the sales revenue from oil and gas production, and this additional levy will be substantial for a typical Chinese oil and gas project reaching the production phase.

The Compensation Fee is not a new charge and was first introduced in 1994 pursuant to the Administrative Measures of Mineral Resources Compensation Fee ("Measures"). However, in accordance with rules enacted by the predecessor of MOLAR, foreign-invested onshore and offshore petroleum projects had been exempt from its application. Following the release of the Notice, the Compensation Fee will be chargeable on petroleum projects as well.

The Compensation Fee is imposed on mineral right holders of petroleum contracts, i.e., the Chinese national oil companies ("NOCs"). Petroleum contracts signed before November 1, 2011 will be exempt from its application but will still be subject to the Resource Tax. The Notice is valid only for a term of eight years, and it is unclear whether production-sharing contracts signed after its expiration in 2020 will be subject to the Compensation Fee.

Although the Compensation Fee is not directly imposed on a foreign contractor, it is possible that foreign contractors may be asked by the NOCs to contribute their share of the fee as an additional cost to a petroleum project. Looking forward, we would expect negotiations and agreements between a foreign contractor and a NOC to include discussion of respective responsibility for this new charge.

NOCs are able to apply for an exemption or a reduction of the Compensation Fee in accordance with the Measures. The Measures set out some factors that would support an application for an exemption or a reduction, including a situation in which the mineral resource is located under water, buildings, or vital communication lines. Even if the reason for a reduction or exemption application is not listed in the Measures, MOLAR and the State Administration of Taxation retain discretion to grant a reduction or exemption.

Lawyer Contacts

For further information, please contact your principal Firm representative or one of the lawyers listed below. General email messages may be sent using our "Contact Us" form, which can be found at www.jonesday.com.

Joanne Du
Hong Kong / Beijing
+852.2526.6895 / +86.10.5866.1230
jdu@jonesday.com

Edith Ho
Hong Kong
+852.3189.7238
edithho@jonesday.com

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