The two companies said they would study the technical and commercial viability of building the 70,000 barrels per day plant, which would equal 1% of China's daily oil demand.
The joint venture is driven by record oil costs, prompting China to utilise its coal reserves, which are the third largest in the world, Bloomberg reported.
Sasol, the world's biggest producer of motor fuel from coal, recently estimated China has the potential for at least 12 coal-to-liquid plants.
According to Shenhua Ningxia general manager Wang Jian, the plant may start operating by 2012.
