China Gas Utilities:Analysis on provinces with potential risks of price reduction

Following Zhejiang's move to reduce gas sales margins, the big question iswhether other provinces will follow suit. In this report, we identify high-riskprovinces as those with high gas sales margins (Guangdong, Hubei, Sichuan)and ones that previously mentioned curtailing gas utilities’ project returns(Anhui and Hebei). Our covered gas utilities have 30-40% of their projectsexposed to these regions, with Towngas China being the most exposed, at40%, based on our estimates.

    Provinces with high dollar margins. Zhejiang, which implemented thefirst gas margin cut, is one of the provinces in China with high dollarmargins on gas sales. If we assume other provinces with above-averagedollar margins follow suit, then the provinces most likely at risk areGuangdong, Sichuan and Hubei (see page 2).

    Gas utilities’ geographic exposure. Guangdong has both high gas sales(13% China’s total) and high gas margins. Gas utilities with large exposureto Guangdong (based on number of projects) are ENN (14% of total) andCR Gas (11% of total).

    Abolition of connection fees? We believe risks to the abolition ofconnection fees are low in the near term because China’s natural gaspenetration rate is only ~35%. If connection fees were removed, gas utilitiesmay not have incentives to connect to new users because residential userstypically provide for dollar margins of Rmb0.3/m3 vs a margin ofRmb0.7/m3 for commercial and industrial users.

    EPS sensitivity. Assuming gas utilities’ gas margins were cut by 20%, thiswould result in 7-10% downside in FY16E EPS, on our estimates.