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Announcement:

Moody's: Zhejiang Province's reduction of natural gas prices has negative implications on city gas operators

 The document has been translated in other languages

25 Apr 2016

Hong Kong, April 25, 2016 -- Moody's Investors Service says the decision by authorities to reduce wholesale and retail natural gas prices in Zhejiang Province has negative implications on Moody's-rated city gas operators.

Moody's views the price cut may have boarder implications for the industry's cost-pass through mechanism if other provinces follow Zhejiang Province's example. The local government's imposition of a ceiling on retail tariffs will also weaken the operators' ability to pass on increased gas costs to end users in the future.

Having said that, Moody's estimates the immediate financial impact on Moody's-rated city gas operators resulting from the price cuts is minimal.

Zhejiang Province's natural gas price adjustments have negative implications on Moody's-rated city gas operators; namely (In alphabetical order):

1) Beijing Enterprises Holdings Limited (A3 review for downgrade),

2) Binhai Investment Company Limited (Ba1 negative),

3) China Oil and Gas Group Limited (Ba2 stable),

4) China Resources Gas Group Limited (Baa1 negative),

5) ENN Energy Holdings Limited (Baa3 positive),

6) Kunlun Energy Company Limited (A1 negative),

7) The Hong Kong and China Gas Co Ltd (A1 stable),

8) Towngas China Company Limited (Baa1 stable), and

9) Zhejiang Provincial Energy Group Co. Ltd (A1 negative).

On 18 April, the Zhejiang pricing bureau announced that it would (1) lower wholesale natural gas prices for commercial and industrial (C&I) users by RMB0.10 per cubic meter to RMB2.19 per cubic meter; (2) set a ceiling on retail tariffs at RMB3.40 per cubic meter; and (3) set a ceiling on the dollar margin for coal-to-gas consumption at RMB0.6 per cubic meter. The adjustments became effective on 20 April.

The announcement followed the local government's recent guidance to lower the operating costs of local corporates -- in view of the slowdown in economic growth -- including reductions in taxes and fees as well as electricity and natural gas charges.

The provincial price cap introduced at the retail level will weaken the ability of city gas operators to pass on increased gas costs to C&I customers in the future. Prior to the introduction of the price cap, operators were able to largely pass through costs to maintain a stable dollar margin on a timely manner.

The development reiterates the evolving nature of China's regulatory regime. Since 2013, the central government has been introducing numerous market price reforms to improve the transparency of the natural gas pricing mechanism and to align gas tariffs according to changing market conditions. However, the price cap in Zhejiang would reduce the flexibility in changing retail tariffs along with the movement of gas costs or alternative fuels.

Moody's will continue to monitor the development and reassess the industry implication should there be further provinces launch similar cost reduction guidelines.

Nevertheless, Moody's expects that the immediate financial impact on the rated city gas operators resulting from the price cut will be minimal.

Most city gas operators -- such as ENN, China Resources Gas, Hong Kong China Gas, Towngas China -- have well-diversified portfolios, and Zhejiang Province's C&I customers only account for 1% - 5% of their total sales volume.

Moreover, their retail tariffs for C&I customers are broadly comparable to the price ceiling of RMB3.4/cubic meter, usually within the range of plus or minus RMB0.1/cubic meters to RMB0.2/cubic meters. Therefore, Moody's estimates their margin compression will likely be limited to 2% or less.

Furthermore, some city gas operators -- such as Beijing Enterprises (including its affiliate China Gas Holdings Ltd (unrated)), China Oil and Gas, Binhai Investment, Kunlun Energy -- have only minimal business exposures to Zhejiang Province and thus, their profitability will unlikely be affected.

Compared to the other rated peers, Zhejiang Energy will be the company that is most affected by these price adjustments, given that its operations are focused in Zhejiang Province.

The company mainly engages in power generation, natural gas transmission and distribution, and coal trading. It is the sole operator of the provincial-level natural gas pipeline. It also has relatively small city gas operations in the province.

Moody's estimates that natural gas-related operations account for 11% of Zhejiang Energy's gross profit. In particular, the dollar margin of its provincial pipeline operations will narrow after the reduction in wholesale prices.

Moody's estimates that the relevant selling prices will fall by 5% or less, but the corresponding reduction in purchase prices is still under negotiation with gas suppliers.

Nevertheless, the overall financial impact on Zhejiang Energy is manageable, given the moderate profit contribution of natural gas operations.

Moody's expects the company's gross profit will fall by around 3% or less based on Moody's expectation on its annual sales volume.

Its strong financial profile also provides adequate headroom against profit compression. The company is diversifying its gas supplies to reduce sourcing costs and enhance its supply mix.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

Ivy Poon
Asst Vice President - Analyst
Project & Infrastructure Finance
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Terry Fanous
MD-Public, Proj & Infstr Fin
Project & Infrastructure Finance
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Releasing Office:
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Moody's: Zhejiang Province's reduction of natural gas prices has negative implications on city gas operators
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