384.pdf

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Initiating Coverage, 11 May 2015

China Gas Holdings (384 HK) Buy Energy & Petrochemicals - Oil & Gas Services Target Price: HKD16.10

Market Cap: USD8,542m Price: HKD13.24

For a Cleaner Sky

Macro 3.00

Risks 1.00

Growth 2.00

Value 2.00

Source: Bloomberg

Avg Turnover (HKD/USD) 144m/18.7m

Cons. Upside (%) 20.5

Upside (%) 21.6

52-wk Price low/high (HKD) 11.1 - 16.1

Free float (%) 41

Share outstanding (m) 5,002

Shareholders (%)

Beijing Enterprises Holdings 22.5

Liu Ming Hui 20.7

SK E&S Co., Ltd. 15.6

Share Performance (%)

YTD 1m 3m 6m 12m

Absolute 8.3 (6.9) 4.9 (2.5) 16.3

Relative (8.8) (12.3) (7.1) (19.9) (10.3)

Shariah compliant

Charles Zhang +852 2103 5842

[email protected]

Source: Company data, RHB

We initiate coverage on CGH, one of Chinas largest natural gas distributors and its biggest LPG distributor, with a BUY and DCF-derived HKD16.10 TP (23x FY16F P/E, 22% upside). We believe CGH is a key beneficiary of the Governments campaign to control air pollution and promote natural gas consumption. We expect cuts in city gate gas prices to lead to higher earnings on higher volumes and GPM improvement.

Strengthened efforts to fight pollution and emissions. The Chinese

Government has strengthened its efforts to tackle pollution. As part of these efforts, we believe the authorities will have to push forward coal to gas projects to achieve the target of doubling natural gas consumption by 2020. We forecast Chinas overall natural gas consumption could witness a fast growth (2014-2020F CAGR: 11.6%, 2014-2025F: 9.2%). A new wave of gas inflows, particularly through the planned Russia-China pipelines, could provide adequate supplies for the shift to gas from coal.

Gas price cut is positive. We believe further cuts in city gate gas prices (such as the one on 1 Apr) could lead to higher earnings, as: i) gas consumption is likely to be stimulated, and ii) GPM could improve as a cut in ASPs vs unit gas costs is likely to be lower in percentage terms, even if the dollar amount of the cut is the same.

China Gas Holdings (CGH) well-positioned to ride the trend. We believe CGH is well positioned to benefit from the industry trend, given its massive exposure to the North-East and North China markets. The strategic alliance with Beijing Enterprises Holdings (BEH) (392 HK, NR), its largest shareholder, could also support its expansion plans in these regions. We expect Chinas strengthened efforts in promoting natural gas consumption to continue driving CGHs growth into the future.

Initiate with BUY, HKD16.10 TP (22% upside). Our DCF-derived TP implies a 23x FY16F (Mar) P/E, which is above the sectors 16.8x average FY15F (Dec) P/E. We think CGH deserves a premium, given its huge exposure to North-East and North China, as well as BEHs support. Please also refer to Figure 3 and 9 for our sensitivity analysis.

Key risks. i) lower-than-expected margins of its liquefied petroleum gas (LPG) business, ii) slower-than-expected growth in natural gas sales, and iii) lower-than-expected connection fee income.

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China Gas Holdings (384 HK)Price Close Relative to Hang Seng Index (RHS)

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Total turnover (HKDm) 17,956 26,008 33,799 41,880 52,805

Reported net profit (HKDm) 1,764 2,576 3,050 3,594 4,172

Recurring net profit (HKDm) 1,644 2,512 3,009 3,594 4,172

Recurring net profit growth (%) 91.1 52.8 19.8 19.5 16.1

Recurring EPS (HKD) 0.37 0.53 0.60 0.71 0.81

DPS (HKD) 0.06 0.08 0.10 0.11 0.13

Recurring P/E (x) 36.0 25.2 22.0 18.7 16.3

P/B (x) 5.27 4.19 3.63 3.23 2.80

P/CF (x) 20.5 18.7 14.5 13.8 11.5

Dividend Yield (%) 0.5 0.6 0.7 0.8 1.0

EV/EBITDA (x) 16.3 14.0 12.3 11.0 9.8

Return on average equity (%) 16.6 18.9 17.9 18.3 18.3

Net debt to equity (%) 80.8 73.0 62.7 53.5 42.5

Our vs consensus EPS (adjusted) (%) (7.8) (11.4) (14.4)

China Gas Holdings (384 HK) 11 May 2015

See important disclosures at the end of this report 2

Table Of Contents Investment Thesis ....................................................................................................... 3

Investment Risks ......................................................................................................... 4

Valuation ..................................................................................................................... 5

Sensitivity To Gas Price Changes ............................................................................... 9

Solid Growth Prospects............................................................................................. 10

Heightened Public Concerns Over Air Pollution ........................................................ 13

Easing Supply Bottlenecks ........................................................................................ 19

Falling Oil Prices Triggers Gas Price Cut .................................................................. 23

Corporate Background .............................................................................................. 26

Overview ................................................................................................................... 27

Most Active Acquisition Player .................................................................................. 28

BEHs Position In CGH To Strengthen After Acquisition ........................................... 30

Major Player In North And North-East China ............................................................ 31

Gas Station Expansion With Focus On CNG ............................................................ 33

LPG Complementary To Piped Gas .......................................................................... 34

Fortune Gas And Zhongyu Gas ................................................................................ 35

On Track To Meet FY15 Targets .............................................................................. 36

Management Background ......................................................................................... 37

Auditors ..................................................................................................................... 37

Financial Exhibits ...................................................................................................... 38

SWOT Analysis ......................................................................................................... 40

Recommendation Chart ............................................................................................ 41



Investment Thesis CGH is one of the top city-gas distributors in China second to China Resources Gas (CR Gas) (1193 HK, BUY, TP: HKD25.60) in terms of volume of gas sold with 250 city-gas projects, the most among its peers. It is also the largest LPG operator with 98 LPG distribution projects. We believe the companys growth will continue to be driven by the Governments strengthened efforts in pushing coal to gas projects and promoting natural gas consumption.

Policy supports key to natural gas consumption. With rising public concerns over

air quality in China, the Chinese Government promised to fight pollution and promote clean energy. Switching from coal to natural gas provides an effective way of reducing emissions and pollution levels. In order to achieve the targets of doubling the share of natural gas in Chinas energy mix and reducing coal consumption, the Government has strengthened its efforts in pushing forward coal to gas switch projects and tightened regulations on emissions. We expect policies to remain supportive of natural gas in the decades to come.

Adequate supplies secured for the shift from coal to gas. China has laid out

specific plans to abolish small coal-fired boilers and replace the capacities with gas-fired boilers. Each province has promised to achieve relevant emission reduction and coal to gas switch targets. A major factor affecting large-scale coal to gas switch projects is supply security. In the past, shortage of supply has caused delays in some of the projects. China has stepped up efforts in securing adequate supplies. There should be adequate supplies of liquefied natural gas (LNG) for China over the next 10 years with new pipeline supplies from Russia of 68bn cu m (bcm) beginning in 2018 and Central Asia.

CGH has the largest presence in North and North-East China. In light of the

upcoming Russian gas pipeline, North and North-East China are expected to see increasing natural gas adoption and further growth in demand. CGH is the largest independent gas distributor in the country with the highest number of gas distribution concessions among peers. We estimate that over 50 of CGHs projects are located in key provinces in these two areas, including Hebei, Liaoning, Jilin and Heilongjiang. The company also has other projects located in other regions of North China. CGH has been able to strengthen its position in North and North-East China after the acquisition of 12 gas distribution projects from BEH. Currently, the company holds the highest number of operating rights in North and North-East China among its peers.

April price adjustment removed uncertainty, a major step of reform. Two factors

may have led to the National Development and Reform Commissions (NDRC) move of cutting city-gate gas prices. One is the sharp drop in crude oil prices since 2H14, while the other is the sluggish consumption growth after the Sep 2014 price hike. As a result of the adjustment in April, the existing volume and incremental volume prices converged into one single price in each province. The NDRC has also moved forward to deregulate the prices for major directly-supplied users, such as power plants, allowing them to negotiate pricing terms with suppliers such as the China National Petroleum Corp (CNPC). We view this as a major step in creating a more transparent and market-oriented pricing mechanism, which will help city gas distributors to better manage costs and negotiate pricing terms with upstream suppliers. The price cut ought to help spur consumption by non-residential users amid slower overall economic growth.

Margins of distributors may benefit. Lower city-gate prices may also benefit

distributors margins. During the 1-2 month period of delay in pass-through, distributors dollar margins per unit of gas sold ought to see an expansion. After the pass-through, ASPs will be lower, but gross margins may improve if dollar margins are maintained. As oil prices remain at low levels, there may be a chance of another round of downward adjustment in city-gate gas prices later this year.

Government efforts to fight air pollution are key for natural gas players in the foreseeable future

Upcoming gas inflows to support large scale coal to gas switch projects

CGH is a major beneficiary of the grand industry trends

Gas price cut a positive move for natural gas consumption and market-oriented reform

Lower city-gate gas prices may benefit distributors margins



Strategic alliance with BEH a plus. BEH is a major state-owned enterprise (SOE)

owned by the Beijing municipal government. A strategic alliance with BEH gives CGH, an independent distributor and the needed SOE support in an industry where frequent negotiations and cooperation with local governments are required. We expect BEH to use CGH as its platform to expand its natural gas business outside Beijing. CGH could also leverage on BEHs SOE status to acquire new projects and deal with the various local administrations.

Investment Risks Falling LPG prices may lead to underperformance of CGHs LPG business. As oil prices have dropped substantially, one concern is that CGH may suffer from further declining LPG prices. According to the company, its LPG retail business may actually benefit from the fall in LPG prices, which should offset the negative impact on its LPG wholesale business.

Sluggish non-residential gas consumption. A going concern is the substitution

effect arising from falling coal and oil prices amid slower economic growth. This will likely reduce the incentive for industrial and commercial users to shift to gas from coal and discourage gas consumption. We expect the impact will probably be limited, given that we see strengthened effort and support by the Government for gas projects. Additionally, after the effective price cut in April, natural gas has regained some popularity with users.

Slower growth in connection fee income as property market cools. As sales of

new residential and commercial properties slow down, connection fee income may also witness slower growth. However, there is still room for growth in connection fees from renewal projects for old buildings, the reconstruction of aged cities and renovation of shanty towns, especially in North-East China. There may be some negative impact on connection fee income due to the cooling property market, but we expect growth in connection fee income to remain largely stable as overall penetration remains low in China.

Removal of the gas connection fee. Currently, only Guangdong and Beijing do not

charge the initial connection fee. We do not see any imminent necessity for local governments to abolish the connection fee policy in other regions. This is because the natural gas penetration rate remains low in most provinces and the promotion of natural gas requires infrastructure investments.

Slower-than-expected economic growth may drag gas consumption. If Chinas economic growth weakens more than expected and industrial and commercial activities slow dramatically, we see natural gas consumption, particularly industrial and commercial demand, to grow much slower than we expect currently.

Strategic alliance with BEH gives CGH support from a major SOE in the city gas distribution space



Valuation DCF-based TP of HKD16.10. Through the DCF method we derive a TP of

HKD16.10, which implies a 22% upside from the current share price. CGHs share price has risen only 7% since the beginning of 2015, and has underperformed the other two major city-gas distributors CR Gas and ENN Energy (2688 HK, NR), which went up 23% and 25% respectively. We believe this is partially due to the fact that the other two players released their 2014 earnings in line with market expectations while CGHs FY15 results would only be reported in June. Additionally investors have concerns over the companys LPG business. We see such concerns are overdone, given that the performance of its LPG retail business with higher margins may offset the impact of low LPG price on its wholesale business. We think CGH deserves to trade at the higher FY16F P/E of 23x rather that at its current 19x multiple, given its leading position in the sector, huge exposure in North and North-East China, higher profit growth and ROE.

Based on our forecasted 10-year free cash flows to the firm (FCFF) from FY16 to FY25, a WACC of 8.1% and TG of 2%, we derive a TP of HKD16.10.

Figure 1: FCFF valuation

Note: *The numbers for FY15 (which ended in March) are shown as reference, and were not included in our 10-year DCF valuation

Source: RHB

Figure 2: DCF variables and fair value Figure 3: DCF sensitivity

Source: RHB Source: RHB

Our TP implies a FY15F P/E of 27x and FY16F P/E of 23x, which are above its historical forward P/E mean of 16x and the current sector average of 16.8x FY15F P/E. We believe the premium is justified due to CGHs faster estimated 3-year EPS CAGR of 16% and higher ROE of 18%. In turn, we believe this is backed by its leading position in the sector, large business portfolio with the most number of projects, strategic alliance with BEH, and massive exposure to North and North-East China. We see gradual improvement in the profitability of CGHs LPG business, backed by the integration of its wholesale business with the high-margin retail wing.

Terminal growth

0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0%

6.5% 17.57 18.74 20.13 21.79 23.81 26.35 29.61 33.95 40.04

7.0% 15.89 16.85 17.97 19.30 20.89 22.84 25.27 28.39 32.56

7.5% 14.44 15.24 16.16 17.24 18.51 20.04 21.90 24.23 27.23

8.0% 13.18 13.85 14.61 15.50 16.53 17.75 19.22 21.01 23.24

WACC 8.1% 12.89 13.54 14.27 15.12 16.10 17.26 18.64 20.33 22.42

8.5% 12.07 12.64 13.28 14.02 14.87 15.86 17.03 18.43 20.15

9.0% 11.09 11.58 12.12 12.74 13.45 14.26 15.21 16.34 17.68

9.5% 10.22 10.64 11.10 11.63 12.22 12.90 13.68 14.59 15.67

10.0% 9.44 9.80 10.20 10.65 11.15 11.72 12.37 13.12 14.00

Variables Fair value (HKDm, unless specified)

Risk free 3.7% SUMPV of cash flows 28,333 Risk premium 6.9% PV of terminal cash flow 61,453

Enterprise Value 89,786 Beta 0.89 Less: Debt 20,653 Cost of equity 9.8% Less: Minority interest 2,852

Add: Cash 7,175 Tax Rate 22% Add: Associates & JVs 7,074 Cost of debt (post-tax) 2.7%

Intrinsic value 80,531 Debt/Capital Ratio 24% No. of shares (m) 5,002

Fair value per share (HKD) 16.10 WACC 8.1%

Terminal growth rate 2.0%

(HKDm, unless specified) FY 2015* FY 2016F FY 2017F FY 2018F FY 2019F FY 2020F FY 2021F FY 2022F FY 2023F FY 2024F FY 2025F

Revenue 33,799 41,880 52,805 63,013 72,480 81,557 88,604 95,012 100,908 106,673 111,903

Operating EBIT 4,102 4,807 5,575 6,324 7,086 7,725 8,374 8,857 9,256 9,638 10,003

Other recurring income 439 523 528 567 580 571 532 475 404 320 224

EBIT (Adjusted) 4,542 5,331 6,103 6,891 7,666 8,296 8,906 9,332 9,659 9,958 10,227

Taxation (Adjusted) (954) (1,119) (1,343) (1,516) (1,686) (1,825) (1,959) (2,053) (2,125) (2,191) (2,250)

Depreciation & amortisation 985 1,309 1,673 1,955 2,259 2,561 2,859 3,154 3,445 3,733 3,961

Change in working capital 669 157 390 194 206 220 419 168 165 164 144

Capital expenditures (5,231) (4,777) (5,016) (5,267) (5,003) (4,753) (4,516) (4,290) (4,075) (4,075) (4,075)

FCFF 10 900 1,808 2,257 3,442 4,498 5,709 6,311 7,069 7,589 8,007

Terminal Cash flow 133,406

Discount Factor 1.01 0.93 0.86 0.80 0.74 0.68 0.63 0.58 0.54 0.50 0.46

PV of FCFF 10 838 1,556 1,796 2,534 3,062 3,595 3,676 3,808 3,780 3,688

PV of Terminal Cash flow 61,453



Figure 4: 2015 YTD share price performance of major city gas distributors

Note: Data as of 8 May. Share prices normalised to 100 at the beginning of 2015

Source: Bloomberg, RHB

Figure 5: CGHs forward P/E band


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CGH CR Gas ENN Energy Towngas China BEH

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Figure 6: Peer Comparison I

Note: Share price as of 8 May.

Adjusted sector avg* only includes HK-listed China gas distribution peers.

CGH, Tokyo Gas, Osaka Gas, Gail Indias FY ends 31 Mar.

The data in the table for CGH represents FY15F, FY16F and FY17F


Price Mkt cap 3-mth avg P/E (x) EPS YoY (%) 3-Yr EPS Div yld (%) P/B (x) Company (local curr.) (USDm) t/o (USDm) FY14A FY15F FY16F FY15F FY16F Cagr (%) PEG (x) FY14A FY15F FY14A FY15F China Gas Holdings 384 HK 13.24 8,541 20.7 22.0 18.7 16.3 17.6 14.4 16.0 1.17 0.7 0.8 3.63 3.23

HSI 27,577 11.7 13.3 12.0 (11.9) 10.7 2.1 6.27 3.0 3.0 1.51 1.43

HSCEI 14,050 10.1 9.9 8.9 2.6 11.0 7.2 1.37 3.1 3.1 1.40 1.30

CSI300 4,558 19.2 16.7 14.6 14.8 14.2 15.2 1.10 1.3 1.6 2.67 2.41

Adjusted sector avg* 21.0 16.8 14.1 25.7 20.7 14.5 1.6 1.5 1.6 2.5 1.9

HK-listed China gas distribution

Beijing Ent 392 HK 72.00 11,927 16.5 19.0 15.7 13.4 21.2 16.9 14.9 1.05 1.2 1.7 1.62 1.49

China Res Gas 1193 HK 24.60 7,056 12.9 21.6 18.3 15.7 18.2 16.4 16.4 1.12 1.0 1.2 3.41 2.95

Kunlun Energy 135 HK 8.90 9,266 25.7 12.8 14.4 12.1 (11.0) 19.1 8.0 1.80 2.6 1.9 1.36 1.25

Enn Energy 2688 HK 54.85 7,662 22.1 16.0 18.5 15.9 (13.4) 16.5 4.1 4.48 0.9 1.6 3.93 3.33

Towngas China 1083 HK 8.39 2,860 5.1 20.9 16.5 14.4 26.4 15.0 15.5 1.07 1.0 1.3 1.67 1.52

China Suntien-H 956 HK 1.88 901 3.2 16.5 12.8 10.0 29.5 28.0 25.5 0.50 3.0 2.6 0.76 0.71

Tian Lun Gas 1600 HK 8.00 854 0.1 23.7 15.6 11.0 51.9 41.5 N/A N/A N/A N/A 4.63 N/A

China Oil And Gas 603 HK 1.04 711 1.7 16.7 9.5 8.0 76.5 18.2 N/A N/A 0.7 0.9 1.53 1.17

Zhongyu Gas Hold 3633 HK 2.26 736 0.1 17.6 15.1 12.6 16.7 20.0 16.8 0.89 N/A N/A 3.78 2.46

Tianjin Jinran-H 1265 HK 2.07 491 0.5 44.8 31.9 27.6 40.5 15.4 N/A N/A N/A N/A 2.18 N/A

Average 21.0 16.8 14.1 25.7 20.7 14.5 1.6 1.5 1.6 2.5 1.9

A-share China gas distribution

Shenzhen Gas -A 601139 CH 10.90 3,817 34.5 30.3 24.8 21.2 21.9 16.9 17.9 1.39 1.3 1.5 3.89 3.57

Chongqing Gas-A 600917 CH 12.36 3,098 30.4 49.4 N/A 41.2 N/A N/A N/A N/A N/A N/A 5.84 N/A

Shanxi Guoxin-A 600617 CH 19.95 3,108 25.1 46.0 31.9 22.5 44.2 41.6 36.2 0.88 N/A N/A 9.64 7.56

Shanghai Dazho-A 600635 CH 15.29 4,051 156.3 72.8 N/A N/A N/A N/A N/A N/A 0.5 N/A 5.71 N/A

Shaan Xi Natur-A 002267 CH 15.48 2,773 33.2 31.4 25.0 18.7 25.9 33.9 N/A N/A 1.0 N/A 3.57 3.23

Xinjiang Haoyu-A 002700 CH 15.42 1,049 24.7 61.7 N/A N/A N/A N/A N/A N/A 0.3 N/A 8.71 N/A

Average 48.6 27.2 25.9 30.7 30.8 27.1 1.1 0.8 1.5 6.2 4.8

Regional gas distribution

Hong Kg China Gs 3 HK 18.56 25,164 23.4 27.5 25.3 23.6 8.6 7.1 7.4 3.43 1.8 2.1 3.71 3.38

Tokyo Gas Co Ltd 9531 JP 687.70 14,019 54.9 17.6 13.8 17.1 27.7 (19.4) 3.4 3.99 1.5 1.5 1.57 1.44

Osaka Gas Co Ltd 9532 JP 483.60 8,394 28.2 13.1 13.3 16.0 (1.5) (16.8) (3.0) N/A 2.0 2.0 1.13 1.09

Korea Gas Corp 036460 KS 49,950.00 4,235 16.8 9.8 10.4 8.5 (5.6) 22.3 8.9 1.17 0.5 1.8 0.45 0.51

Petronas Gas Bhd PTG MK 22.80 12,548 6.1 24.5 25.2 24.6 (2.8) 2.3 0.4 58.94 2.6 2.7 4.29 3.99

Gas Malaysia Bhd GMB MK 2.67 953 0.7 20.4 28.4 23.2 (28.0) 22.3 (2.8) N/A 5.0 3.1 3.46 3.33

Perusahaan Gas N PGAS IJ 4,045.00 7,478 12.1 10.3 10.3 10.0 0.0 3.3 3.2 3.19 3.6 4.9 2.51 2.39

Rukun Raharja Pt RAJA IJ 1,335.00 104 0.2 13.2 10.2 5.1 29.9 100.0 N/A N/A 0.9 1.0 2.08 1.96

Gail India Ltd GAIL IN 369.00 7,313 8.7 9.8 12.6 12.7 (22.1) (1.3) (4.0) N/A 2.4 2.4 1.44 1.35

Average 16.2 16.6 15.6 0.7 13.3 1.7 14.1 2.2 2.4 2.3 2.2



Figure 7: Peer Comparison II

Note: Share price as of 8 May.

Adjusted sector avg* only includes HK-listed China gas distribution peers.

CGH, Tokyo Gas, Osaka Gas, Gail Indias FY ends 31 Mar.

The data in the table for CGH represents FY15F, FY16F and FY17F


Rev FY14A NP FY14A EV/Ebitda (x) Net gearing (%) Gross margin Net margin ROIC (%) ROE (%) Sh px % Company (USDm) (USDm) FY14A FY15F FY14A FY15F Unlev beta (%) FY14A (%) FY14A FY14A FY14A FY15F 1-mth 3-mth China Gas Holdings 3,354 332 19.5 14.9 62.7 53.5 0.48 20.3 9.9 8.9 17.9 18.3 (6.9) 4.9

HSI 12.9 10.8 5.1 11.7

HSCEI 13.8 13.2 4.9 20.1

CSI300 13.9 14.4 6.1 37.6

Adjusted sector avg* 13.7 11.0 44.5 45.6 0.5 24.7 9.5 6.8 13.3 12.0 4.5 20.5

HK-listed China gas distribution

Beijing Ent 6,183 623 23.9 20.1 37.9 30.1 0.41 17.9 10.1 2.8 8.7 9.5 11.3 23.7

China Res Gas 3,704 320 12.6 11.5 24.8 27.6 0.62 30.4 8.6 8.3 16.4 16.4 (3.5) 22.7

Kunlun Energy 6,197 724 6.5 6.4 19.9 28.5 0.88 45.1 11.7 8.1 10.9 9.1 7.6 10.7

Enn Energy 4,685 478 11.8 10.4 32.1 35.5 0.59 20.9 10.2 10.5 27.4 19.8 2.3 26.5

Towngas China 1,017 136 19.2 16.7 39.8 32.9 0.31 28.9 13.4 4.2 8.2 9.4 6.2 18.7

China Suntien-H 829 54 9.0 7.2 88.5 118.2 0.30 25.2 6.5 4.3 5.0 5.9 (12.6) 14.6

Tian Lun Gas 216 35 14.4 N/A 53.3 N/A (0.06) 34.3 16.4 9.5 21.3 19.3 1.4 (0.6)

China Oil And Ga 993 40 8.3 5.4 33.9 46.5 0.59 15.0 4.0 5.5 8.6 10.5 0.0 4.0

Zhongyu Gas Hold 440 42 12.1 10.4 114.5 N/A 0.34 24.9 9.5 N/A 17.8 15.5 (1.7) 14.7

Tianjin Jinran-H 233 11 19.5 N/A 0.0 N/A 1.09 4.9 4.7 8.1 8.6 4.8 34.4 69.7

Average 13.7 11.0 44.5 45.6 0.5 24.7 9.5 6.8 13.3 12.0 4.5 20.5

A-share China gas distribution

Shenzhen Gas -A 1,526 116 22.6 17.0 40.9 33.2 0.34 18.8 7.6 10.0 13.1 14.8 (4.2) 10.3

Chongqing Gas-A 913 58 32.4 N/A 0.0 N/A N.A 13.8 6.3 7.8 11.9 N/A (8.0) 20.9

Shanxi Guoxin-A 883 70 29.2 22.5 314.0 N/A 0.02 21.1 7.9 N/A 26.9 24.6 (5.6) 13.8

Shanghai Dazho-A 665 55 79.4 N/A 24.1 N/A 0.93 10.8 8.2 0.5 8.2 N/A 24.3 82.2

Shaan Xi Natur-A 853 83 16.2 13.8 53.7 N/A 0.36 17.8 9.7 8.7 13.7 12.9 1.8 12.0

Xinjiang Haoyu-A 55 17 43.3 N/A 0.0 N/A 0.64 46.0 30.7 13.4 14.9 N/A (3.7) 36.3

Average 37.2 17.8 72.1 33.2 0.5 21.4 11.7 8.1 14.8 17.4 0.8 29.3

Regional gas distribution

Hong Kg China Gs 4,078 930 24.5 21.7 30.8 29.5 0.57 N/A 22.8 6.0 13.9 13.9 1.6 6.4

Tokyo Gas Co Ltd 19,101 798 7.4 7.1 55.1 N/A 0.61 N/A 4.2 6.2 9.2 10.4 (13.9) (3.2)

Osaka Gas Co Ltd 12,733 639 7.8 7.2 50.3 N/A 0.63 N/A 5.0 4.4 9.1 8.8 (5.3) 2.1

Korea Gas Corp 34,258 411 15.8 14.2 312.7 364.7 N.A 3.8 1.2 2.0 4.8 4.4 30.9 11.0

Petronas Gas Bhd 1,220 512 15.2 14.5 2.3 N/A 1.31 50.4 42.0 14.4 17.7 16.3 (1.0) 1.9

Gas Malaysia Bhd 771 47 11.9 15.9 0.0 N/A 0.64 9.0 6.0 15.3 18.9 11.7 (0.7) (14.1)

Perusahaan Gas N 3,409 723 7.0 7.1 19.7 10.8 0.91 43.0 21.2 11.5 24.9 24.0 (15.4) (23.0)

Rukun Raharja Pt 197 8 5.5 4.7 15.7 N/A 0.82 15.8 4.0 10.9 16.5 17.8 (14.4) (21.5)

Gail India Ltd 9,635 748 8.0 9.2 44.4 32.7 0.94 N/A 7.8 9.0 15.6 11.0 (10.1) (12.1)

Average 11.4 11.3 59.0 109.4 0.8 24.4 12.7 8.9 14.5 13.1 (3.1) (5.8)



Sensitivity To Gas Price Changes GPM may improve if dollar margins are maintained after a price cut. After the

city-gate gas price cut in April, local governments and distributors will start to address the issue of pass-through. Understandably, it is in the best interest of a distributor to delay the price cut pass-through as they will be able to enjoy margins expansion. Eventually, though, the pass-through has to be completed. When distributors negotiate with the local authorities on this, they will try to maintain their dollar margins. As this is most likely the case, distributors will likely see an expansion in their GPM (see Figure 8 below).

Figure 8: Impact of adjustment in city-gate prices on gross margins

Source: RHB

In practice, industrial users may respond positively to lower gas prices by increasing their consumption. In the sensitivity table below (Figure 9), we apply a short-term elasticity of -0.7 for industrial users. This means that a 1% decrease in gas price will cause a 0.7% increase in industrial gas consumption. More importantly, we assume that the amount of gross profit per unit of gas sold (dollar margin) stays the same.

Our sensitivity analysis for CGH shows that further cuts in ASP will lead to increases in our TP given constant dollar margins. Supposing there was a 5% cut in ASP for FY16 (vs our current assumption of 3% cut in FY16 ASP), our FY16 net recurring profit forecast will be raised by 0.7% (growth will rise to 20.3% YoY from 19.5% YoY) and our DCF-based TP will be lifted to HKD16.38 (from HKD16.10), which implies a 24% upside (vs a 22% upside implied by our current TP) to the current share price.

Figure 9: Assuming elasticity of -0.7 for industrial users, dollar margin per unit of gas sold are maintained and other variables being constant

Source: RHB

Citygate price

End-user

price

Dollar margin per

unit of gas sold

Sales

volume

Sales

revenue

Gross

margin Gross pofit

(CNY/cu m) (CNY/cu m) (CNY/cu m) (cu m) (CNY) (%) (CNY)

Down Down Maintained Positive Negative* Positive Positive

Up Up Maintained Negative Positive* Negative Negative

Note: assuming 1% change in end-user price causes less than 1% change in end-user demand.

Change in FY16 average selling price -15.0% -10.0% -5.0% -3.0% +0.0% +5.0% +10.0%

FY16 Gas sales volume (m cu m) 13,236 12,964 12,692 12,583 12,420 12,148 11,875 YoY +34.3% +31.5% +28.7% +27.6% +26.0% +23.2% +20.5%

FY16 Gas sales (HKDm) 16,490 17,101 17,672 17,889 18,203 18,694 19,146 YoY +14.1% +18.4% +22.3% +23.8% +26.0% +29.4% +32.5%

FY16 Total revenue (HKDm) 40,481 41,092 41,663 41,880 42,194 42,685 43,137 YoY +19.8% +21.6% +23.3% +23.9% +24.8% +26.3% +27.6%

Gross profit - Sales of gas (HKDm) 3,227 3,161 3,095 3,068 3,028 2,962 2,896 YoY +34.3% +31.5% +28.7% +27.6% +26.0% +23.2% +20.5%

Gross margin - Sales of gas 19.6% 18.5% 17.5% 17.2% 16.6% 15.8% 15.1%

Gross profit (HKDm) 8,128 8,062 7,996 7,969 7,929 7,863 7,796 YoY +21.5% +20.6% +19.6% +19.2% +18.6% +17.6% +16.6%

Gross margin 20.1% 19.6% 19.2% 19.0% 18.8% 18.4% 18.1%

FY16 EBITDA (HKDm) 6,382 6,269 6,160 6,117 6,053 5,950 5,849 YoY +25.5% +23.2% +21.1% +20.2% +19.0% +17.0% +15.0%

EBITDA margin 15.8% 15.3% 14.8% 14.6% 14.3% 13.9% 13.6%

FY16 Recurring profit (HKDm) 3,744 3,681 3,619 3,594 3,558 3,498 3,440 YoY +24.4% +22.3% +20.3% +19.5% +18.2% +16.3% +14.3%

Net margin 9.2% 9.0% 8.7% 8.6% 8.4% 8.2% 8.0%

FY16 Recurring EPS (HKD) 0.74 0.73 0.71 0.71 0.70 0.69 0.68 YoY +22.5% +20.5% +18.4% +17.6% +16.4% +14.5% +12.6%

DCF-TP (HKD) 17.80 17.08 16.38 16.10 15.69 15.03 14.38

Upside (May.8 Close HKD13.24) +34.4% +29.0% +23.7% +21.6% +18.5% +13.5% +8.6%



Solid Growth Prospects Growth likely to remain strong for FY15-FY17. We expect CGH to continue to

deliver strong revenue growth in FY15-FY17, supported by rising gas sales, improved LPG business and to a lesser extent connection fee income. We expect total YoY revenue growth to reach 30% (FY15), 24% (FY16) and 26% (FY17), representing FY15-17 CAGR of 25%. Proportion of revenue from piped gas sales and the LPG business may increase to 44% and 46% in FY17 from 42% and 43% in FY14 respectively. Meanwhile, the share of connection fee income will drop to 10% in FY17 from 15% in FY14.

Figure 10: CGHs revenue breakdown


Overall GPM to be lower as proportion of connection fee income falls.

Connection fee income entails much higher GPM (67-69%) than gas sales (17-20%) and the LPG business (6-8%). We forecast for the proportion of connection fee income to gradually fall and, in turn, CGHs overall GPM will decrease to 18% in FY17 from 20% in FY14.

Figure 11: CGHs gross profit breakdown


(HKDm) FY13A FY14A FY15F FY16F FY17F

Total revenue 17,956 26,008 33,799 41,880 52,805

YoY -5% 45% 30% 24% 26%

% of total revenue 100% 100% 100% 100% 100%

Sales of piped gas 7,352 10,885 14,448 17,889 23,210

YoY -4% 48% 33% 24% 30%

% of total revenue 41% 42% 43% 43% 44%

Gas connection 2,709 3,837 4,552 4,949 5,321

YoY -3% 42% 19% 9% 8%

% of total revenue 15% 15% 13% 12% 10%

Sales of LPG 7,887 11,277 14,773 19,013 24,242

YoY -1% 43% 31% 29% 28%

% of total revenue 44% 43% 44% 45% 46%

Sales of coke & gas appliances 8 9 25 28 32

YoY -98% 13% 180% 12% 12%

% of total revenue 0.04% 0.03% 0.1% 0.1% 0.1%

(HKDm) FY13A FY14A FY15F FY16F FY17F

Total 3,776 5,286 6,688 7,969 9,562

YoY 5% 40% 27% 19% 20%

% of total gross profit 100% 100% 100% 100% 100%

GPM 21% 20% 20% 19% 18%

Sales of piped gas 1,456 1,992 2,404 3,068 3,981

YoY - 37% 21% 28% 30%


GPM 20% 18% 17% 17% 17%

Gas connection 1,840 2,579 3,155 3,430 3,682

YoY - 40% 22% 9% 7%


GPM 68% 67% 69% 69% 69%

Sales of LPG 457 756 1,123 1,464 1,891

YoY - 65% 49% 30% 29%


GPM 6% 7% 8% 8% 8%

Others 23 (40) 6 7 8

YoY - -271% -116% 10% 10%

% of total gross profit 0.6% -0.8% 0.1% 0.1% 0.1%

GPM 293% -446% 25% 25% 24%



Figure 12: CGHs detailed P&L statement


(HKDm) FY12A FY13A FY14A FY15F FY16F FY17F 1HFY14 2HFY14 1HFY15 2HFY15

31 Mar. 31 Mar. 31 Mar. 31 Mar. 31 Mar. 31 Mar. 30 Sep. 31 Mar. 30 Sep. 31 Mar.

Actual Actual Actual Forecast Forecast Forecast Actual Actual Actual Forecast

Total revenue 18,934 17,956 26,008 33,799 41,880 52,805 10,461 15,547 15,588 18,211

YoY change 19.4% -5.2% 44.8% 30.0% 23.9% 26.1% - - 49.0% 17.1%

Cost of sales (15,328) (14,180) (20,722) (27,112) (33,911) (43,243) (7,984) (12,738) (12,434) (14,678)

Gross profit 3,606 3,776 5,286 6,688 7,969 9,562 2,477 2,809 3,154 3,533

YoY change 23.9% 4.7% 40.0% 26.5% 19.2% 20.0% - - 12.3% 12.0%

Gross profit margin 19.0% 21.0% 20.3% 19.8% 19.0% 18.1% 23.7% 18.1% 20.2% 19.4%

Selling expenses (733) (661) (871) (1,132) (1,361) (1,716) (368) (503) (520) (612)

Admin expenses (939) (1,127) (1,200) (1,453) (1,801) (2,271) (516) (685) (634) (820)

Operating expenses (1,672) (1,788) (2,071) (2,585) (3,162) (3,986) (884) (1,188) (1,154) (1,431)

Opex as % of revenue 8.8% 10.0% 8.0% 7.6% 7.5% 7.5% 8.4% 7.6% 7.4% 7.9%

Operating profit 1,934 1,988 3,215 4,102 4,807 5,575 1,593 1,621 2,000 2,102

YoY change 32.1% 2.8% 61.7% 27.6% 17.2% 16.0% - - 23.4% 5.1%

Operating margin 10.2% 11.1% 12.4% 12.1% 11.5% 10.6% 15.2% 10.4% 12.8% 11.5%

Other income 305 368 349 439 523 528 218 130 414 25

Non-recurring items 132 144 79 52 - - 25 55 53 (1)

Interest income 79 77 57 74 91 115 35 21 45 29

Finance cost (916) (691) (615) (812) (916) (986) (335) (280) (311) (502)

Share of results of JV/associates 86 552 636 611 757 954 298 338 238 372

PBT 1,620 2,437 3,721 4,467 5,263 6,187 1,835 1,885 2,440 2,026

YoY change 47.7% 50.4% 52.7% 20.1% 17.8% 17.6% - - 33.0% 7.5%

PBT margin 8.6% 13.6% 14.3% 13.2% 12.6% 11.7% 17.5% 12.1% 15.7% 11.1%

Income tax (479) (400) (741) (938) (1,105) (1,361) (351) (391) (483) (455)

Effective tax rate 29.5% 16.4% 19.9% 21.0% 21.0% 22.0% 19.1% 20.7% 19.8% 22.4%

MI (188) (272) (404) (478) (564) (654) (202) (202) (277) (201)

Net profit - reported 954 1,764 2,576 3,050 3,594 4,172 1,283 1,293 1,680 1,370

YoY change 52.4% 84.9% 46.0% 18.4% 17.8% 16.1% - - 30.0% -18.4%

NPM (reported) 5.0% 9.8% 9.9% 9.0% 8.6% 7.9% 12.3% 8.3% 10.8% 7.5%

Net profit - recurring 861 1,644 2,512 3,009 3,594 4,172 1,263 1,249 1,638 1,371

YoY change 40.0% 91.1% 52.8% 19.8% 19.5% 16.1% - - 31.1% -16.3%

NPM (recurring) 4.5% 9.2% 9.7% 8.9% 8.6% 7.9% 12.1% 8.0% 10.5% 7.5%

EPS - recurring (HKD) 0.20 0.37 0.53 0.60 0.71 0.81

YoY change 36.9% 87.1% 43.0% 14.6% 17.6% 14.4%



Healthy balance sheet. We expect capex to be lower at around HKD5.2bn in FY15

and HKD4.8bn in FY16 vs HKD5.9bn in FY14, mainly for new project acquisitions and the maintenance of existing projects. CGH had relatively high net debt to equity ratio at 73% in FY14. We expect this ratio to fall to 63% and 53% in FY15 and FY16 respectively. The major M&A activity announced in FY15 is the acquiring of Beijing Gas Development Ltd (BGD) for a total consideration of HKD2.06bn that will be completed through the issuance of new shares to the seller, and should not affect its debt level. CGHs most recent debt financing activity is the USD300m (HKD2.3b) syndicated loan offered by a group of investors led by the IFC, a member of the World Bank, to support its expansion plans in city gas distribution and gas refilling stations. We expect CGH's operating cash flow to grow to HKD4.6bn-6.8bn in FY14-16, supported by sustained growth in its businesses. Additionally, we expect the companys receivable, inventory and payable days to remain largely stable at 66, 21, and 109 at the end of FY15 vs 65, 20, and 108 at the end of FY17 respectively.

Figure 13: CGHs accounts receivable, payable and inventory days


0

20

40

60

80

100

120

FY12A FY13A FY14A FY15F FY16F FY17F

Receivable days Iinventory days Payable days



Heightened Public Concerns Over Air Pollution China has one of the worst air pollution among major economies. Smog and

PM2.5 (particulate matter with a diameter of 2.5 microns or less) air quality monitoring gauge are the hottest topics in China nowadays. As pollution has become increasingly visible in major cities like Beijing, public concerns over air quality have grown drastically in recent years. Air pollution has not only resulted in domestic concerns, but has also garnered international attention, adding pressure to the Chinese Government to address the relevant issues. Below is an excerpt from a Wall Street Journal report on Beijings air pollution titled Why Leave Job in Beijing? To Breathe:

The impact of high air-pollution levels on long-term health weighs on Chinese and foreigners alike. A recent analysis led by the Boston-based Health Effects Institute estimated outdoor particulate matter in China was responsible for roughly 1.2m premature deaths in China in 2010, ranking it just behind tobacco smoking.

In the wake of soaring air-pollution readings in Beijing, many expatriate workers are choosing to leave China due to the health risks.

Figure 14: Smog in Beijing (Feb 2013 and Feb 2014)

Source: Wikimedia, , Kentaro Iemoto

According to World Health Organisation (WHO) data, China has one of the worst air quality readings among major economies, only second to India. The concentration of PM2.5 in China is 4x the levels guided by the WHO, and in countries like Japan and Canada. Among the 112 Chinese cities in WHOs database, Haikou has the lowest PM2.5 level at 18.4 micrograms (g)/cu m, which is still over 80% higher than WHOs guidance.

Figure 15: PM2.5 annual mean of selected countries (g /cu m)

Source: WHO

Title:

Source:

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Heightened public concern over air quality offers an opportunity for natural gas



Coal is a major contributor to air pollution in China. China has a long history of

reliance on coal as a major source of energy. Based on BPs (BP/ LN, NR) world energy statistics, in 2013, Chinas coal consumption alone accounted for over half of the worlds total. After experiencing severe air pollution in the 1950s, advanced economies like the UK started to tighten air quality monitoring and regulations. This led to a continued decline in coal consumption and the commoditys proportion in total energy consumption among the major industrialised countries since the 1960s. While other major economies have reduced coal consumption and increased usage of cleaner energy like natural gas, Chinas demand for coal has been soaring since the start of the 21

st century. Currently, coals share in total primary energy

consumption is around 19% in Organisation for Economic Co-operation and Development (OECD) countries and 17% in European countries. In China, the proportion of coal in total energy consumption was around 67% in 2013 and 66% in 2014 based on 2014 preliminary figures by the National Bureau of Statistics of China (NBS).

Figure 16: Coal consumption Figure 17: Coal as a share in primary energy consumption

Source: BP Source: BP

According to research by Natural Resources Defense Council (NRDC), the amount of sulphur dioxide (SO2), nitrogen oxide (NOx) and smoke dust created by direct combustion of coal in 2012 accounted for 79%, 57% and 44% of total air pollutants emissions in China respectively. Meanwhile, SO2, NOx and smoke dust emitted by coal-related key industries accounted for 15%, 13% and 23% of the countrys total pollutants emissions respectively. The contribution of coal usage to Chinas overall level of PM2.5 concentration is over 50%, ranging from 37-63% at the provincial level. According to research by Tsinghua University, 63% of the amount of PM2.5 emission is related to the process of coal usage. This includes 31% coming from direct coal combustion.

Figure 18: Coal consumption's contribution to concentration of PM2.5

Figure 19: China's PM2.5 emission breakdown by sources

Source: Tsinghua University, NRDC Source: Tsinghua University, NRDC

Title:

Source:


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500

1,000

1,500

2,000

2,500

1965

1967

1969

1971

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1977

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1981

1983

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(m boe)

China US EU UK

Germany Japan India

Title:

Source:


0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1965

1967

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1971

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1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

China US EU UK

Germany Japan India

Scenario analysis Possible range

National (average) 56.0% 51%~61%

BTH-region 50.9% 51%~62%

Beijing 43.9% 44%~54%

Tianjin 49.9% 50%~60%

Hebei 51.6% 52%~62%

Yangtze River Delta 54.1% 54%~61%

Shanghai 53.3% 53%~63%

Jiangsu 53.2% 53%~63%

Zhejiang 55.3% 55%~65%

Guangdong 47.3% 47%~57%

Shandong 54.2% 54%~64%

PM2.5 emission ('000 tons) Share (%)

Power generation 890 7%

Heating 410 3%

Industrial boilers 1,110 9%

Industrial production 4,790 40%

Residential 4,350 36%

Moving sources 470 4%

Total 12,030 100%

Among which:

Directly related to coal burning 3,750 31%

Indirectly related to coal usage 3,780 31%



In light of the heavy emission levels related to coal usage in China, reducing coal consumption and increasing other cleaner energy consumption, such as natural gas, shall be the most effective and practical way to control emission and improve air quality in the near future.

Plan laid out to fight air pollution. China has officially declared war on smog and

pledged to fight it with the same determination the country battled poverty. In Sep 2013, Chinas State Council published the Action Plan For Air Pollution Prevention and Control, targeting a 10% reduction in concentrations of large particulate matter

(PM10) in all Tier-2 and Tier-3 cities. The action plan also targeted a 25%, 20% and 15% reduction in concentration of PM2.5 in three key regions, namely the: i) Beijing-Tianjin-Hebei (BTH), ii) Yangtze River Delta (YRD), and iii) Pearl River Delta (PRD), by 2017 compared to levels in 2012. According to another newly published Energy Development Action Plan 2014-2020, the three regions will see a decline in coal consumption by 2020. In order to effectively implement the Action Plan For Air Pollution Prevention and Control, the Environmental Protection Ministry has signed liability agreements on the pollutants reduction and coal consumption control targets. All the targets of each province have been made public and will be adopted as one of the performance indicators in the evaluation of local officials. In a certain sense, meeting the targets of pollution control and emission reduction can be regarded as political missions for these local officials.

Reduction in coal-fired boilers a key component of the plan. One key element of

the action plan is the elimination of coal-fired boilers or conversion to gas-fired boilers. According to the targets set in the plan, coal consumption will be strictly controlled in most regions and is to see negative growth or a major reduction (when compared with 2012) in key provinces in the BTH, YRD and PRD by 2017. All the provinces will basically abandon coal-fired boilers with capacities below 10 tonnes of steam per hour (t/h) by 2017, and will not add any new coal-fired boilers with capacity below 20t/h. Certain provinces, including Beijing and Tianjin, will also stop adding any new coal-fired boilers. The near-term goal is to reduce 200,000t/h of coal-fired boilers capacity by the end of 2015.

Expecting continued progress in coal to gas projects. In the process of

elimination and conversion of coal-fired boilers, there are two major options, namely upgrading to cleaner coal-fired boilers with desulphurisation, denitrification and dust

removal equipments, and coal to gas projects (), in which the eliminated capacity of coal-fired boilers will be replaced with gas-fired ones. The main factors to be considered when making the choice between the two options are cost and adequacy of natural gas supply.

According to the research by the Chinese Research Academy of Environmental Sciences (CRAES), China has over 610,000 industrial boilers. Based on the data in the report, we estimate that over 400,000 units, or around 70% of all industrial boilers, are coal-fired ones with a total capacity of around 4mt/h in China. These coal-fired boilers consume over 730m tonnes of coal annually, accounting for over 20% of Chinas total coal consumption. This is in drastic comparison with the US, where about 80% of boiler units and 51% of industrial boiler capacity are natural gas-fired.

Another characteristic of coal-fired boilers in China is that the majority are small and inefficient. In terms of units, 67% of coal-fired boilers are below 10t/h, and over 80% are below 20t/h. These small boilers are usually are sold at lower prices with limited or zero environmental protection functions. The designed thermal efficiency is 70-80%, but the actual operating efficiency may be only 60% or even lower. This has led to wastage of fuels and high emissions of pollutants.

One major obstacle for coal to gas projects is the issue of cost. The investment for a coal-fired boiler for upgrading and the addition of the necessary environmental protection equipment, and the cost to purchase a new gas-fired boiler are almost the same. If you add the expense of extra space and area required for the environmental protection facilities of an upgraded coal-fired boiler, the cost of a new gas-fired one may be even cheaper.

The major difference lies in operating cost. As coal prices have dropped substantially over the past few years, and the price of natural gas has actually increased in domestic market, coal is now trading at over a 70% discount to natural gas in terms of the same amount of energy released. However, the cost advantage of coal may be offset by the running cost of environmental protection facilities, low thermal efficiency, and high maintenance cost of coal-fired boilers. This is even more obvious in the case of small boilers.



On the other hand, China has tightened regulation and published stricter emission requirements for industrial boilers. The new pollutants emission standards for boilers, which were implemented in Jul 2014, are much more demanding. They require 50% less emissions of dust and SO2, and added the standards for NOx, mercury and its compounds. This would further increase the running cost of coal-fired boilers in order to meet the new emission standards.

Figure 20: Targets of coal-burning boilers elimination and conversion

Source: NDRC, Provincial governments, RHB

Province Coal-fired boilers

reduction target 2014-

2015 (t/h)

Boilers reduction plan by 2015 Boilers reduction plan by 2017 Coal reduction by 2017 from 2012 (m tonnes)

PM2.5 reduction by 2017 from 2012)

Shandong 23,000 All urban below 10t/h abolish/refit, no addition of coal-fired boilers

-20 (capped at 380) -20%

Hebei 22,000 All urban below 10t/h abolish/refit All urban below 35t/h abolish/refit, no addition of coal-fired boilers

-40 -25%

Zhejiang 14,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below

Negative growth -20%

Tianjin 12,000 All urban below 10t/h abolish/refit All urban below 35t/h abolish/refit, no addition of coal-fired boilers

-10 -25%

Jiangsu 11,000 By 2016 all urban below 10t/h abolish/refit, no addition of 20t/h & below


Shanxi 10,000 All urban below 10t/h abolish/refit Abolish 4,000 units coal-fired boilers, no addition of coal-fired boilers in urban area

Zero growth in Taiyuan (provincial

capital)

-20%

Liaoning 10,000 All urban below 10t/h abolish/refit, 2,000 units coal-fired boilers, no addition of 20t/h & below

capped at 201 (2012: 182.19)

-10% (PM10)

Heilongjiang 10,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below

Strictly control -5% (PM10)

Henan 10,000 All urban below 10t/h abolish/refit, no addition of 20 t/h & below


Beijing 9,000 All below 10t/h abolish/refit All above 10t/h abolish/refit, no addition of coal- fired boilers

-13 (capped at 10) -25%

Inner Mongolia

9,000 All urban below 10t/h abolish/refit, no addition of 20 t/h & below

Increase energy efficiency

-10%

Shaanxi 8,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below


Anhui 6,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below

Strictly control -10%

Jilin 5,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below


Shanghai 5,000 All urban below 10t/h abolish/refit, no addition of 20 t/h & below


Guangdong 5,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below

Negative growth (PRD)

-15% (PRD); -10% (PM10, Provincial).

Hubei 4,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below

strictly control -12% (PM10)

Yunnan 4,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below


Continued improvement

Xinjiang 4,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below


Fujian 3,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below


Hunan 3,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below


Gansu 3,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below


Jiangxi 2,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below


Sichuan 2,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below


Ningxia 2,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below


Guangxi 1,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below


Chongqing 1,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below


Guizhou 1,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below

Reasonably control -5% (PM10)

Qinghai 1,000 All urban below 10t/h abolish/refit, no addition of 20t/h & below


Hainan - All urban below 10t/h abolish/refit, no addition of 20t/h & below



Tibet - All urban below 10t/h abolish/refit, no addition of 20t/h & below



Total 200,000



Figure 21: Emission standard of air pollutants for coal-fired boilers

Note: Key region refers to protected areas; region 1 refers to nature reserves and protected areas; region 2, 3 refer to residential and industrial areas.

Source: Ministry of Environmental Protection (MEP)

Figure 22: Emission standard of air pollutants for gas-fired boilers


Source: MEP

Figure 23: Emission standard of air pollutants for oil-fired boilers


Source: MEP

Coal-fired boilers Unit: mg/cu m

Coal-fired boilers (New standards: GB 13271-2014)

Particulate matter (smoke & dust) SO2 NOx Mercury & its compounds Smoke density (Ringelmann scale)

Boilers in use (Oct 2015) 80 400~550 400 0.05 1

Boilers newly built (Jul 2014) 50 300 300 0.05 1

Boilers in key regions 30 200 200 0.05 1

Coal-fired boilers (Old standards: GB 13271-2001)


Natural draft boiler (region 1) 80~100 900~1,200 - - 1

Natural draft boiler (region 2, 3) 120~150 900~1,200 - - 1

Others (region 1) 80~100 900~1,200 - - 1

Others (region 2, 3) 200~350 900~1,200 - - 1

Gas-fired boilers Unit: mg/cu m

Gas-fired boilers (New standards: GB 13271-2014)


Boilers in use (Oct 2015) 30 100 400 - 1

Boilers newly built (Jul 2014) 20 50 200 - 1

Boilers in key regions 20 50 150 - 1

Gas-fired boilers (Old standards: GB 13271-2001)


Gas-fired boilers (all regions) 50 100 400 - 1

Oil-fired boilers Unit: mg/cu m

Oil-fired boilers (New standards: GB 13271-2014)


Boilers in use (Oct 2015) 60 300 400 - 1

Boilers newly built (Jul 2014) 30 200 250 - 1

Boilers in key regions 30 100 200 - 1

Oil-fired boilers (Old standards: GB 13271-2001)


Light diesel/kerosene (region 1) 80 500~700 400 - 1

Light diesel/kerosene (region 2, 3) 100 500~700 400 - 1

Other oil-fired boilers (region 1) 80~100 900~1200 400 - 1

Other oil-fired boilers (region 2, 3) 150~200 900~1200 400 - 1



National carbon trading scheme to be launched in 2016. Besides setting higher

emission requirements, China planned to launch a nationwide carbon emission permit trading programme in 2016. In Phase I (2016-2019) of the plan, China will first build a unified national platform and, in phase II, (2019 onwards), the scheme coverage will be enlarged and improved. Under the scheme, carbon dioxide emission will be capped at sources such as enterprises in power generation, metallurgical, nonferrous metal, building materials, chemicals and aviation. Those enterprises emitting above their cap will have to purchase extra quotas in the carbon trading market. Since 2013, China has already started seven pilot carbon trading programmes in Shenzhen, Beijing, Shanghai, Tianjin, Guangdong, Hubei and Chongqing. The country has also made significant progress in emission control and building a cap-and-trade market. We expect a national carbon trading scheme to increase emission costs and provide more incentives for enterprises to switch from carbon-intensive fuel like coal to cleaner energy such as natural gas.

Figure 24: Chinas seven carbon trading pilots

Source: Resources for the Future (RFF), Shanghai Environment and Energy Exchange (SEEE)

Pilot Start date Initial

quota

(m tonnes)

Number of

entities

covered

2014

trading

volume

(m tonnes)

2014

turnover

(CNYm)

2014

average

price

(CNY/tonne)

Recent

carbon price

18 Mar 2015

(CNY/tonne)

Shenzhen Jun 2013 33 635 1.85 114 61.8 42.9

Beijing Nov 2013 50 543 2.11 105 49.7 51.5

Shanghai Nov 2013 160 191 1.97 75 38.3 25.4

Guangdong Dec 2013 408 193 1.27 66 51.9 20.2

Tianjin Dec 2013 160 114 1.01 21 20.3 25.1

Hubei Apr 2014 324 138 7.00 167 23.9 26.1

Chongqing Jun 2014 125 242 0.15 4 29.7 24.0



Easing Supply Bottlenecks Supply security a concern in certain regions. In many regions, there have been

delays to coal to gas projects. This has been mainly due to supply bottlenecks. As reported by the China Environment News, after the Phase I project was finished,

Tianjins Chentangzhuang () Power Plant Chinas largest gas-fired power plant did not have enough gas supply for its trial operation. The Government is aware of this issue and has been actively expanding sources of supply to support coal to gas projects.

We estimate that over 30% Chinas natural gas supply in 2014 relied on imports. Based on our forecasts, in 2015, the countrys domestic gas output will reach 158bcm while consumption will rise to 199bcm. This implies a shortfall of 41bcm. To meet the growing demand, China has sought supplies globally. Currently, about half of the countrys natural gas imports come through pipelines while the other half is in the form LNG. In 2013, imported pipeline gas amounted to 27bcm while LNG imports reached 24bcm. In terms of pricing, pipeline natural gas on average enjoy an about 20-30% discount to LNG.

Figure 25: Natural gas domestic production and consumption

Source: NDRC, NBS, BP, RHB

In May 2014, Russias Gazprom (GAZP RM, NR) and CNPC signed a 30-year contract, in which the former will supply natural gas to China from 2018 through the Power of Siberia pipeline. During the first five years, annual gas delivery is expected to rise gradually to 30bcm from 5bcm. From 2023 onwards, the amount will stay at 38bcm per year. This roughly represents over 10% of Chinas forecasted consumption in 2020. The gas pipeline will enter China at Heihe in Heilongjiang Province, targeting markets in North-East China, and the BTH and YRD regions. Additionally, in Nov 2014, the Chinese and Russian Governments signed a memorandum of understanding (MoU) to pursue a western route, ie the Altai pipeline, potentially delivering 30bcm of natural gas to the East Asian nation annually. According to a recent speech by Chinas Foreign Minister Wang Yi, the two nations are to sign an official agreement on the Western Russia-China pipeline by this year. In total, the eastern and western Russia-China pipelines may deliver 68bcm of natural gas annually, meeting close to 20% of Chinese demand by 2020.

However, there is still a question on which one of the two routes, the Power of Siberia or the Altai pipeline, will be launched first. It was reported by Reuters in March that there may be a delay in the construction schedule of the eastern route due to funding reasons. Since mid-2014, oil prices have dropped over 50% and remain below USD60 per barrel now. This has put pressure on international oil companies income and spending. Although the delay in the western route has not been officially confirmed, we see it is logical for Gazprom to pursue the Altai pipeline (the western route) as a priority over the Power of Siberia pipeline (the eastern route), mainly due

to cost and strategic considerations. It has been estimated that the construction of the eastern route would cost over USD20bn without considering the development spending for the East Siberian gas fields, which still require more work in order to start commercial production.

0

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Production Consumption



On the other hand, the western route would cost around USD15bn and Russia is actively seeking new customers for the West Siberian gas resources as an alternative for its traditional European buyers. So, in terms of construction cost and strategic benefits, Russia would naturally consider the western route as a priority, but this is not a preferred pipeline for China, given that it needs to secure adequate supplies for its affluent provinces in the east. Besides, the western route would require extra spending and time to build thousands of miles of new transmission infrastructures for China to pump the gas across the country to customers in the east. After all, the precise timing of the launch of operation of the eastern route and the signing of an agreement on the western route are largely political decisions. We still expect the two governments to honour their official agreements and launch the projects on time.

Besides the Russia-China gas pipelines, the Chinese Government is stepping up efforts to obtain natural gas supplies from various other directions and sources. Turkmenistan has already agreed to more than double its gas deliveries to China to 65bcm by 2020 from the current level of 30bcm per annum through the Central Asia Gas Pipeline (CAGP). In 2013, China added natural gas imports from Kazakhstan through the CAGP as well as Myanmar through a newly-built pipeline in South-West China.

Unconventional gas output to rise in the medium to long term. Meanwhile, China

is also developing its own unconventional gas resources including shale gas and coal-bed methane (CBM) to mitigate reliance on imports. According to the Energy Information Administration (EIA), the country holds the largest reserves of technically recoverable shale gas in the world. However, shale exploration & production (E&P) have met with difficulties. This has led the Government to cut shale gas output target to 30bcm by 2020 from 80bcm. We still expect shale gas output to meet about 8% of demand in China in 2020. Besides shale gas, the country is also stepping up the development of CBM and coal-to-gas projects. We expect shale gas, CBM and coal-to-gas projects to become substantial supply factors in the medium to long term.

Figure 26: Russia-China natural gas pipelines

Source: Gazprom, RHB

In this context, natural gas, as a cleaner alternative to coal, is a practical energy option for China due to its availability and mature technologies. While coal will remain a major energy source in the foreseeable future, the Chinese Government has set targets to increase the proportion of natural gas in Chinas energy mix. The Government expects that, in 2020 and 2030, natural gas will account for 10% and 12% of Chinas primary energy consumption respectively. This represents a substantial increase from 2013s 5% but is still largely below the current global average. There is enormous room for expansion in natural gas consumption in China. We are expecting the grand plan of a shift away from coal, which may unleash the countrys potential for natural gas consumption and be a further boost to demand.

Title:

Source:


Two planned routes of Russian gas pipelines, one in the east (to begin supplies by 2018) and the other in the west



Figure 27: China natural gas imports Figure 28: China natural gas apparent consumption

Source: NDRC, CEIC, RHB Source: NDRC, CEIC, RHB

Slightly slower natural gas consumption projection. In our previous forecasts, we

stated that the countrys natural gas demand could grow at CAGRs of 12.3%, 9.5% and 7.7% for 2014-2020, 2014-2025 and 2014-2030 respectively. As the preliminary 2014 growth rate of natural gas consumption released by NDRC was only 5.6%, the slowest in the past few years, we slightly lower our forecasts through 2015 to 2030. We are now expecting natural gas consumption to grow at CAGRs of 11.6%, 9.2% and 7.5% for 2014-2020, 2014-2025 and 2014-2030. The demand seems to be well covered by adequate natural gas supply through both domestic and external sources. We are still optimistic about the supply and demand conditions in the future.

Figure 29: China's natural gas demand

Source: NDRC, RHB

Title:

Source:


-30%

0%

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(m cu m)

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Title:

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2010 2011 2012 2013 2014E 2015F 2020F 2030F

(bcm)



Figure 30: China natural gas demand/supply model

Source: NBS, CNPC, BP, RHB

Unit: (bcm) 2011 2012 2013E 2014E 2015F 2016F 2017F 2018F 2019F 2020F 2025F 2030F

Demand

Total demand 131 146 162 179 200 226 255 287 317 346 468 565

yoy 22% 12% 10% 11% 12% 13% 13% 12% 10% 9% - -

Agriculture 0.06 0.06 0.07 0.08 0.09 0.09 0.10 0.11 0.12 0.13 0.19 0.24

yoy 12% 15% 10% 11% 9% 9% 9% 9% 9% 9% - -

% of Total demand 0.04% 0.04% 0.04% 0.04% 0.04% 0.04% 0.04% 0.04% 0.04% 0.04% 0.04% 0.04%

Industrial 39 47 52 55 62 71 81 90 99 108 142 160

yoy 22% 21% 10% 11% 12% 15% 13% 12% 10% 9% - -

% of Total demand 30% 32% 32% 31% 31% 32% 32% 31% 31% 31% 30% 28%

Chemical 23 25 26 29 32 34 36 38 40 41 45 46

yoy 25% 7% 3% 14% 8% 7% 7% 5% 5% 3% - -

% of Total demand 18% 17% 16% 17% 16% 15% 14% 13% 13% 12% 10% 8%

Pow er generation 22 23 26 29 35 42 51 61 70 79 117 158

yoy 19% 4% 15% 14% 20% 20% 20% 20% 15% 12% - -

% of Total demand 17% 15% 16% 17% 18% 19% 20% 21% 22% 23% 25% 28%

Commercial (Wholesale & Retail & Hotel & Catering Service) 3 4 5 6 8 9 10 11 12 13 18 24

yoy 24% 15% 25% 29% 20% 15% 13% 11% 10% 9% - -

% of Total demand 3% 3% 3% 4% 4% 4% 4% 4% 4% 4% 4% 4%

Construction 0.13 0.13 0.13 0.14 0.15 0.15 0.15 0.15 0.16 0.16 0.17 0.18

yoy 10% -1% 2% 11% 2% 2% 2% 2% 2% 2% - -

% of Total demand 0.10% 0.09% 0.08% 0.08% 0.07% 0.07% 0.06% 0.05% 0.05% 0.05% 0.04% 0.03%

Transportation (Transport & Sotrage & Post) 14 15 18 19 21 23 26 29 32 35 51 66

yoy 30% 12% 15% 5% 10% 11% 12% 12% 10% 10% - -

% of Total demand 11% 11% 11% 11% 10% 10% 10% 10% 10% 10% 11% 12%

Residential 26 29 32 36 39 43 48 54 60 66 91 108

yoy 17% 9% 12% 11% 10% 10% 12% 12% 11% 10% - -

% of Total demand 20% 20% 20% 20% 20% 19% 19% 19% 19% 19% 19% 19%

Others 3 3 3 3 3 3 3 3 3 3 4 4

yoy 38% 21% -8% 11% 0% 0% 0% 0% 0% 0% - -

% of Total demand 2% 2% 2% 2% 2% 1% 1% 1% 1% 1% 1% 1%

Supply

Total supply/capacity 137 151 173 194 241 299 326 359 386 432 538 584

yoy 22% 11% 14% 12% 24% 24% 9% 10% 8% 12% - -

Domestic production 104 109 121 136 158 187 207 225 245 260 313 359

yoy 9% 4% 11% 12% 16% 19% 11% 9% 9% 6% - -

% of Total supply 76% 72% 70% 70% 65% 63% 63% 63% 63% 60% 58% 61%

Conventional 103 107 118 128 139 150 160 170 180 185 214 239

yoy 8% 4% 10% 9% 8% 8% 7% 6% 6% 3% - -

% of Total supply 75% 71% 68% 66% 58% 50% 49% 47% 47% 43% 40% 41%

Shale gas output - 0.0 0.2 1 5 10 15 20 25 30 45 60

yoy - - 700% 550% 285% 100% 50% 33% 25% 20% - -

% of Total supply - 0% 0% 1% 2% 3% 5% 6% 6% 7% 8% 10%

CBM 2 2 3 4 5 12 17 20 25 30 39 45

yoy 50% 11% 46% 23% 39% 140% 42% 18% 25% 20% - -

% of Total supply 1% 1% 2% 2% 2% 4% 5% 6% 6% 7% 7% 8%

Coal to gas - - 3 3 9 15 15 15 15 15 15 15

yoy - - - 8% 233% 67% 0% 0% 0% 0% - -

% of Total supply - - 1% 1% 4% 5% 5% 4% 4% 3% 3% 3%

Imports 32 42 52 58 83 112 119 134 141 172 225 225

Pipeline (capacity) 16 21 27 31 48 72 74 89 96 122 165 165

yoy 337% 38% 27% 15% 53% 50% 3% 20% 8% 27% - -

% of Total supply 11% 14% 16% 16% 20% 24% 23% 25% 25% 28% 31% 28%

Russia - - - - - - - 5 10 25 68 68

Turkmenistan 16 21 24 25 36 51 51 56 56 65 65 65

Kazakhstan - - 0.1 0 3 5 5 10 10 10 10 10

Uzbekistan - 0 3 2 5 10 10 10 10 10 10 10

Myanmar - - 0.2 3 4 6 8 8 10 12 12 12

LNG (capacity) 17 21 24 27 35 40 45 45 45 50 60 60

yoy 30% 24% 19% 10% 30% 14% 13% 0% 0% 11% - -

% of Total supply 12% 14% 14% 14% 15% 13% 14% 13% 12% 12% 11% 10%



Falling Oil Prices Triggered Gas Price Cut Effective cut in city-gate prices. Amid falling oil prices, the NDRC announced an

effective cut in city-gate gas prices across China beginning 1 Apr for non-residential users. Based on our estimates, the average incremental volume price will be cut to CNY2.51 per cu m (-14.9%) from CNY2.95 per cu m while the average existing volume price will be raised to CNY2.51 per cu m (+1.5%) from CNY2.47 per cu m. This move effectively achieves the NDRCs goal to see the two prices for non-residential users converge by the end-2015. After 1 Apr, there will be only one single city-gate price for non-residential users in each province.

Figure 31: City-gate prices before and after Aprils adjustment

Source: NDRC, RHB

Due to the differences in prices and volumes across provinces, distributors and users, it is hard to precisely measure the scale of the adjustment in city-gate prices with one standard. The impact on each distributor and user in different regions primarily depends on the mix of existing and incremental volumes. The higher the incremental volume, the higher the price cut they can enjoy. This would encourage natural gas consumption, especially for users with low existing volume. As we previously assumed, if the ratio between incremental and existing volume is 4:6, we should see an effective cut of about 5.7%. However, if the ratio is 2:8, the effective cut should be only around 2.2%.

Figure 32: Effective changes under different weighting

Source: RHB

After the adjustment in April, the average city-gate price across the country is now at CNY2.51 per cu m. However, based our estimates (see Figure 33), if the NDRC strictly follows its own formula and closely tracks the current fuel oil and LPG prices, the city-gate prices may be even lower. For example, assuming oil price rebound to USD70 per barrel (vs. RHB forecasts of USD72.50 per barrel/USD80 per barrel for 2015/2016) and using the estimated 6-month moving average prices for fuel oil and LPG, we may see the corresponding gas price to be at around CNY2.11 per cu m based on NDRCs formula.

(CNY/cu m) Before Apr15 After Apr15 Before Apr15 After Apr15

Existing

volume

Incremental

volume

Citygate Existing

volume

Incremental

volume

Citygate

Shanghai 2.84 3.32 2.88 Shanxi 2.57 3.05 2.61

Guangdong 2.86 3.32 2.88 Jilin 2.42 2.90 2.46

Zhejiang 2.83 3.31 2.87 Heilongjiang 2.42 2.90 2.46

Jiangsu 2.82 3.30 2.86 Guizhou 2.37 2.85 2.41

Anhui 2.75 3.23 2.79 Yunnan 2.37 2.85 2.41

Henan 2.67 3.15 2.71 Sichuan 2.33 2.79 2.35

Guangxi 2.69 3.15 2.71 Hainan 2.32 2.78 2.34

Beijing 2.66 3.14 2.70 Chongqing 2.32 2.78 2.34

Tianjin 2.66 3.14 2.70 Ningxia 2.17 2.65 2.21

Hebei 2.64 3.12 2.68 Gansu 2.09 2.57 2.13

Liaoning 2.64 3.12 2.68 Inner Mongolia 2.00 2.48 2.04

Shandong 2.64 3.12 2.68 Shaanxi 2.00 2.48 2.04

Jiangxi 2.62 3.10 2.66 Qinghai 1.93 2.41 1.97

Hubei 2.62 3.10 2.66 Xinjiang 1.81 2.29 1.85

Hunan 2.62 3.10 2.66

Average 2.47 2.95 2.51

(CNY/cu m)

Weight (%) Existing/base 90% 85% 80% 75% 70% 65% 60%

Incremental 10% 15% 20% 25% 30% 35% 40%

Before Apr15 Existing

volume avg.2.47 2.47 2.47 2.47 2.47 2.47 2.47

Incremental

volume avg.2.95 2.95 2.95 2.95 2.95 2.95 2.95

Weighted

average2.52 2.54 2.57 2.59 2.61 2.64 2.66

After Apr15 2.51 2.51 2.51 2.51 2.51 2.51 2.51

Effective change (%) -0.3% -1.3% -2.2% -3.1% -4.0% -4.9% -5.7%



Figure 33: Estimated gas price based on NDRC's netback pricing formula

Source: China Customs, NDRC, EIA, RHB

Again the adjustment in city-gate prices is still a decision of the NDRC and not a purely market-based mechanism. Hence, it is hard to make a definite judgement on the timing of the next adjustment. The NDRC will also need to take into account the impact of price adjustments on upstream natural gas producers and importers like CNPC. We reckon that, if international oil prices stay at current levels until 2H15, we may see an increasing chance of cuts in city-gate prices later this year.

Natural gas consumption to be stimulated. The intention of this round of

adjustments is to maintain the discount of natural gas alternative fuels. And we expect users who are sensitive to energy costs will consume more natural gas after they observe lower gas prices. In particular, those relatively new users will have more incentives to use natural gas as they have high percentage of incremental volume and can enjoy much lower prices. However, we should not overestimate the stimulus to natural gas consumption, given that industrial activities remain relatively sluggish.

Market-based pricing for directly-supplied users. Another major policy change is

applied to those directly-supplied users who receive natural gas directly from upstream producers and major pipeline operators. These users will be able to negotiate pricing terms with their suppliers starting in April. There are concerns that this may affect the operation of city gas distributors if users seek to obtain supplies directly from major producers and pipeline operators. We see the threat of the new policy is limited, given that the operating rights of the city gas distributors are protected by law. It is also not easy to for upstream suppliers to supply gas directly to users due to lack of pipeline infrastructure.

Estimates Estimates Estimates Actuals Actuals Actuals Actuals Actuals Actuals Actuals

Unit: Mar-15 Feb-15 Jan-15 Dec-14 Nov-14 Oct-14 Sep-14

Oil price (Brent) USD/barrel 70 60 50 56 58 48 62 79 87 97

% Change +25.3% +7.4% -10.5% -3.8% +21.6% -23.4% -21.5% -9.1% -9.9% -4.4%

from Mar-15 from Mar-15 from Mar-15 MoM MoM MoM MoM MoM MoM MoM

Gas price est. CNY/cm 2.11 2.06 2.00 2.21 2.38 2.56 3.00 3.40 3.74 4.03

% Change -4.2% -6.7% -9.2% -7.4% -6.9% -14.8% -11.5% -9.2% -7.3% -0.1%

6-Month moving average

Fuel oil price CNY/kg 2.54 2.48 2.41 2.72 3.01 3.31 4.02 4.59 5.05 5.45

% Change -6.7% -9.0% -11.4% -9.4% -9.2% -17.6% -12.4% -9.2% -7.3% -0.4%

LPG price CNY/kg 3.68 3.58 3.49 3.72 3.90 4.04 4.50 5.00 5.50 5.93

% Change -1.0% -3.6% -6.3% -4.6% -3.4% -10.3% -10.0% -9.2% -7.2% +0.5%

References (import data from the General Administration of Customs)

Fuel oil price est. CNY/kg 2.69 2.30 1.92 2.15 2.00 2.15 2.88 3.37 3.78 3.85

% Change +25.3% +7.4% -10.5% +7.3% -6.9% -25.4% -14.5% -10.8% -1.8% +0.3%

LPG price est. CNY/kg 4.10 3.51 2.93 3.27 3.36 3.55 3.88 3.93 4.32 4.35

% Change +25.3% +7.4% -10.5% -2.7% -5.3% -8.4% -1.3% -9.1% -0.7% +4.3%

Fuel oil imports

Volume 10,000 tons 144 157 129 190 125 115 117

Value 10,000 CNY 308,910 313,928 277,196 547,616 421,494 434,799 450,282

LPG imports

Volume 10,000 tons 216 241 283 275 254 209 209

Value 10,000 CNY 706,557 810,119 1,004,795 1,066,441 998,341 903,902 909,852



Figure 34: Oil and natural gas prices Figure 35: Domestic fuel prices

Source: Bloomberg Source: NBS, Bloomberg

Impact on distributors. In theory, the gas price cut pass-through should be faster

and easier than a price hike, as it faces less resistance from end-users. However, only a few provinces and cities like Tianjin, Shandong and Zhejiang have announced pass-through plans. The overall speed of pass-through still largely depends on the negotiations between distributors and local price bureaus. Distributors will have great incentives to slow down the pass-through process. In practice, we expect there to be a delay of 1-2 months before any full pass-through is seen. Dollar margin per unit of gas sold of distributors should increase during the delay and their GPMs will also benefit. Furthermore, if distributors can maintain their dollar margin after pass-through, we may see an expansion in gross margins and profit.

After all, lower end-user prices will provide incentives for users to consume more natural gas. This is especially so for those relatively new subscribers as they have more incremental volumes and can enjoy bigger effective reduction in prices. In an environment of slower economic growth, lower natural gas costs means a great deal to those industrial and commercial users.

Due to the difference in mix of incremental volume and existing volume, the scale and impact of the city-gate price cut varies across distributors. In practise, it is difficult to accurately calculate the ratio between incremental and existing volumes for distributors as there are additions or disposals of projects. Additionally, city-gate prices are also different across China. With the disclosed volume data, we estimated the possible changes in gas prices for each distributor (see Figure 36 below).

Figure 36: City-gate price change estimates for selected distributors

Note: D

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