China Energy Gas:Potential gas price hike suggests reform progress for sector/PetroChina

Potential gas price hike in November would be a positive move.

    PetroChina plans to raise non-residential gas prices by 10% on November20, according to sina.com. The news article reports that PetroChina isexpecting gas supply to be tight in the winter heating season and isplanning to take advantage of a November 2015, National Developmentand Reform Commission (NDRC) policy which would allow gas price hikes(up to 20%) based on negotiations between buyers and sellers.

    We think given the general government policy stance to lower energy costsfor the economy now, PetroChina’s ability to raise gas prices in response tomarket dynamics serves as a testament to progress in gas reform. Thatsaid, we believe part of the potential gas price hikes will likely be absorbedby downstream utilities and pipeline operators (based on recent policydetails on regulated 8% return for pipelines effective January 2017).

    PetroChina: Potential EPS accretion on seasonal hike likely limited.

    We think it is a balancing act between price and volume for PetroChina. Weexpect it is easier to raise prices in Northern China where a gas shortagecould be more serious in the winter. Under our conservative assumptions, a10% gas price hike for six months (seasonal) for only 30% of its gas saleswould raise PetroChina’s 2017E net profit by about 3%, all else equal.

    Downstream utilities: A full cost past-through may be difficult.

    Our channel checks indicate downstream distributors have not startednegotiating gas prices with PetroChina. We believe it may take some timeto adjust retail gas tariffs in the peak season. We also think regulators havebeen aiming to cut gas consumption costs for industrial and commercialusers since early 2016 (e.g., Zhejiang has recently lowered retail gas tariff).

    We, therefore, think it may be difficult to fully pass through cost hikes toend users in regions with higher tariffs and profit margins.

    Top picks: PetroChina (H) (Buy) and Beijing Enterprise (Buy, CL).

    PetroChina (H): We expect the following to re-rate shares from recentEV/DACF trough levels and underperformance vs. peers: 1) favorable risks todomestic gas prices; 2) dividend potential; and 3) range-bound oil prices.

    Beijing Enterprises: We expect strong heating demand and new power plantlaunches to accelerate gas sales volume growth in 4Q16. We see BeijingGas’ low profitability making pass-through more likely vs. peers.