OREANDA-NEWS. Fitch says that China's move to reduce natural gas prices for the city gas sector for the first time in a decade is likely to benefit city gas distributors. The revision may boost natural gas demand in the short term, without hurting margins on their gas supply operations.

Fitch expects this price adjustment to help city gas distributors to boost their gas sales volume in the short term. In 2014, China's total natural gas consumption volume recorded a growth rate of just 5.1% to 176 billion cubic meters, the weakest growth in the past decade. The sluggish demand growth was due to a combination of both the slowdown in the industrial sector as well as increased price competitiveness of substitution fuels such as liquefied petroleum gas (LPG) and gasoline with the fall in global oil prices since the second half of 2014. The near 15%-20% reduction in the price of incremental gas volumes would effectively enhance the cost competiveness of natural gas and is likely to boost the sales volumes of domestic leading natural gas distributors such as China Resources Gas (BBB+/Stable) and ENN Energy (BBB/Stable).

However, we do not expect any material dollar margin change for the city gas operators from the reduction in city-gate price of incremental gas volumes. That is because generally gas is procured on a monthly basis at costs that are reflective of current market prices, and the majority of the city gas price change will also be passed-through to the end users, like the price increases before.

China's reduction of natural gas prices will be effective from 01 April 2015 and reflects the fall in global crude oil prices. On 28 February 2015, China's National Development and Reform Commission (NDRC) announced the alignment of the two tiered natural gas city-gate price applicable for non-residential users by reducing the price for "incremental volume" (based on 2012 consumption levels) by CNY0.44 per cubic meter (a reduction of around 15%-20%). The NDRC also lifted the price for "existing volume" by CNY0.04 per cubic meter effective from 1 April 2015. The unified city-gate price will be broadly based on a 15% discount over the heat value adjusted price of LPG and gasoline combined, the formula based on which "incremental volumes' were priced since July 2013.

The unification of the prices, albeit only for non-residential users for the moment, is a further step towards a truly market oriented pricing model for gas in China. In the same announcement, NDRC mentions that the "direct purchase" gas price (i.e. end users directly purchasing gas from upstream companies) - which was set by NDRC previously - will now only need to be agreed between the seller and buyer, and in future through the specialised Shanghai Oil & Gas Exchange Centre to be established. NDRC has indicated that once this model has been validated, city-gate gas prices for all non-residential customers could be based on a similar market oriented model. In Fitch's view, this could be beneficial to the city gas distributors' credit profiles by removing exposure to gas price risk, provided however, NDRC allows reasonable distribution tariffs for city gas operators, that are at least on par with the margin earned by them under the current model.

In addition, the NDRC's announcement affirmed its plan to adopt a laddered natural gas tariff for residential users nationwide by end of 2015, which could also increase the gas distributor's profit from the residential segment. Residential gas tariffs in the majority of the gas-connected cities have not been adjusted for over two years, despite three revisions to non-residential gas prices since July 2013.