From The Wall Street Journal
Isn’t being a Chinese company in a strategic sector great? Industries deemed critical by Beijing often benefit from cheap capital, tax breaks and protection—implicit or explicit—from foreign competition. That is, until policy priorities change.
China’s city gas utilities, market darlings earlier this year, now find themselves in this position. ENN Energy Holdings 2688 3.17% is down 14% in Hong Kong since last week’s news that megacity Chongqing may curtail the fees companies charge consumers to hook up to their gas networks. Competitors China Resources Gas and Kunlun Energy are down 9% and 3% respectively. Some analysts are calling this a buying opportunity. Yet things may get worse before they get better.
Connection fees are less important than they appear. For ENN, they were only 12% of sales in 2017, according to FactSet. What’s worrying is the overall policy signal. China now has plenty of customers for natural gas: Penetration rates are around 50% according to Jefferies. What China doesn’t have is enough gas to go around. Demand growth surged 15% last year. Domestic output growth was just 8%, leading to huge losses for state energy firms on pricey imported gas.
Beijing knows rectifying this problem means raising prices for wholesale gas, which would allow drillers and pipeline builders to generate higher profits and spur investment. But it doesn’t want those higher prices passed on to Chinese households.
The logical consequence is a squeeze on gas-utility margins. The crunch has already been visible. Gas distributor shares sold off sharply in late May as well, following news they would have to pay more for wholesale gas earmarked for household use. Beijing last month published a new blueprint for the gas sector that proposed the development of a pricing mechanism where upstream and downstream prices move together. But in reality regulators are likely to retain discretion to set prices for some time. If domestic gas-supply growth disappoints again in 2019, more moves to shift profits from utilities to upstream producers such as PetroChina seem likely.
Private-sector company ENN, whose shares have returned nearly 500% to investors over the past decade, looks particularly vulnerable given the Xi administration’s preference for state-owned firms. Its operating margins, already at a 10-year low according to FactSet, might have further to fall.
Gas is destined to play a much bigger role in China’s future. Gas utilities’ profits, perhaps not so much.
