By Patrick Hu and Gilbert Zeng

Website: www.jonesday.com

Foreign investors' access to China's coal market can be traced back to the late 1970s, most notably symbolized by the mid-1980 landmark joint venture (JV) between Occidental Petroleum Corp and China National Coal Development Corp. Over the past decades, foreign companies have invested some US$1 billion in this still tightly controlled industry. Recent years have indeed witnessed dramatic reform and restructuring in China's coal industry. Becoming the world's largest coal producer, China has seen its coal production grow by 9.7% in the first half of 2005 over the same period in 2004, reaching 940 million tons. Meanwhile, China's domestic coal demand is expected to reach a robust 2.1 billion tons in 2005, and an estimated 2.5 billion tons in 2010. Faced with the most dynamic coal production and consumption market in the world, it is not surprising that foreign players such as Itochu and Anglo American are strengthening their participation in the industry via strategic equity acquisitions and partnerships.

Regulatory Environment

Foreign Investment Catalogue ­ Pursuant to the latest Foreign Investment Industrial Guideline Catalogue, effective as of January 1, 2005, foreign coal players are encouraged to invest through either JVs or wholly foreign-owned enterprises (WFOEs) in: (i) exploration and development of coal and related resources, such as, most significantly, coal-bed methane; (ii) comprehensive development and utilization of clean coal, such as gasified coal, liquefied coal, water-coal, industrial-type coal and; (iii) coal ore-dressing and washing, and comprehensive utilization of coal ash (including desulfurized gypsum) and coal refuse. The survey and exploitation of special-types of rare coal (e.g., coking coal and lean coal) are generally restricted to foreign investors through JVs only, with no more than 49% foreign ownership.

Exploration and Mining ­ The centerpiece of China's regulatory regime on the mining industry is the PRC Mineral Resources Law, promulgated on March 19, 1986 and revised on August 29, 1996. The law lays the foundation for regulating the exploration and development of mineral resources, including coal, and calls for the issuance of further regulations and rules to advance the general principles provided therein. Significantly, the PRC Mineral Resources Law establishes a licensing system under which a coal explorer must obtain an exploration permit. Further, a mining permit and associated resources tax and compensation fee are required for coal mining activities. Both exploration permits and mining permits are transferable to foreign investors and legally permitted to be injected as capital contribution in Sino-foreign JVs, subject to mandatory appraisals and other statutory conditions.

Production and Distribution ­ Another key piece of legislation, the PRC Coal Law, was promulgated on August 29, 1996, as a means of promoting a more regulated, transparent and predictable market environment particularly for coal production and distribution activities in China. Under the PRC Coal Law and the related regulations and implementing rules, a prospective coal miner is required to obtain, in addition to a mining permit, a coal production licence and a safety production licence for its coal mining business. Separately, a coal distribution licence is required for a sole coal distributor or a coal miner that distributes coal products made by others.

Quotas and Tariffs

Long used by China to protect industries of national interest, export quota requirements still exist for coal exports from China and are detailed in the Administrative Measures on Coal Export Quotas issued on January 7, 2004. Pursuant to these measures, an annual quota is determined and published by the State Development and Reform Commission and the Ministry of Commerce by October 31 of the preceding year and allocated to the licensed State-owned coal exporting applicants in a two-phase approach - 80% by December 15 of the preceding year and 20% by June 30 of the current year. As China has disclosed in its Protocol on the Accession to the WTO, only four State-owned coal players are licensed for coal exporting activities. These include China National Coal Industry Import & Export Company, China National Metals and Minerals Import & Export Company, Shanxi Coal Import & Export Group Company, and the Shenhua Group.

Current tariff levels on coal products differ, depending primarily upon the nature of the relevant products and in some cases upon whether the PRC market is in actual demand. Recently, for instance, China introduced tariff reductions on thermal coal and anthracite to 3% and eliminated the tariff on coking coal in order to encourage the import of such coal products to meet the domestic demand.

Conclusion

Our recent experience in handling foreign-invested coal projects has revealed that while the opportunities in the PRC coal market may be appealing, foreign investors are well advised to take precautions in addressing the specific risks and uncertainties involved in their transactions by seeking proper financial and legal advice.