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Press Release: Fitch: China Gas Reforms to Initially Squeeze Operator Margins

1 Jun 2018 4:14 am
 
 
The following is a press release from Fitch Ratings: 
 

Fitch Ratings-Hong Kong/Shanghai/Singapore-01 June 2018: The Chinese authorities' decision to relax controls on the city-gate price of gas sold to operators for residential users is likely to slightly narrow operators' dollar margins, at least temporarily, and boost the profits of upstream suppliers, says Fitch Ratings. This latest reform is an important step in the authorities' medium-term move towards full gas price liberalisation.

The changes announced by the National Development and Reform Commission (NDRC) on 25 May 2018 will mean that most city-gate gas prices for residential users converge with prices for non-residential users from 10 June 2018. Residential city-gate prices are currently CNY0.2-0.3/cbm lower than non-residential city-gate prices on average, according to our estimates, and will therefore rise. Initial price hikes will be capped at CNY0.35/cbm, with any excess gradually eliminated over the following year. Residential city-gate prices will then follow the same mechanism as for non-residential prices from June 2019. This allows seasonal city-gate price increases of up to 20%, with no floor on downward adjustments. The changes apply only to piped gas, which accounted for about 30%-40% of gas consumption - other gas prices are already de-regulated.

City-gas operators' procurement costs will rise as a result of the initial adjustment, and then become more volatile under the new price mechanism. The NDRC will allow local governments to decide on the pass-through of higher city-gate prices to residential consumers, taking into account local affordability and the profitability of operators, and has suggested providing subsidies to low-income and coal-to-gas rural users.

Operators have stated they expect strong pass-through of higher costs to customers, but there have often been delays in the past, which could point to at least a temporary narrowing of dollar margins. The impact on operators' profits will also depend on the share of sales accounted for by residential users. China Resources Gas Group (CRG), for example, is more exposed than ENN, as 25% of CRG's gas sales by volume are to residential users, compared with 11% at ENN. Nevertheless, we only expect the ex-VAT dollar margins of the Fitch-rated city-gas operators - CRG, ENN and Binhai - to decline by CNY0.02-0.03/cbm initially, assuming 70% of the cost increase is passed onto consumers.

The bigger impact could come over the medium term, as the government continues its efforts to bring down gas prices for consumers to boost demand and gas penetration, which could put pressure on operators' margins. That said, operators' cost could be lowered by expanded infrastructure access and the establishment of trading exchanges to increase competition between gas suppliers, while higher gas sales could mitigate the impact of any pressure on margins.

The residential sector currently accounts for around 20% of total Chinese gas demand. The profits of upstream gas suppliers will receive an initial boost from the decision to relax residential city-gas prices. We estimate that a CNY0.35/cbm price hike could boost the profit of PetroChina by CNY6 billion-7 billion. However, we expect gas price controls will gradually be phased out and future profitability will depend on gas supply and demand dynamics.

Contact:

Cecilia Chan

- Associate Director

- Corporates

- +852 2263 9905

- Fitch (Hong Kong) Limited

- 19/F, Man Yee Building

- 68 Des Voeux Road Central

- Hong Kong

Penny Chen

- Director

- Corporates

- +86 21 6898 7996

Dan Martin

- Senior Analyst

- Fitch Wire

- +65 6796 7232

Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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