China Natural Gas Reports on Success of CNG Business Segments

| China

Tankers filling up from a CNG compressor station

US-registered China Natural Gas, Inc. (CHNG) is a provider of compressed natural gas (CNG) for vehicular fuel in Xi’an, China. The city of Xi’an has approximately 20,000 taxis, 5,000 buses and 3,000 special purpose vehicles that are powered by compressed natural gas. Profitable CHNG business segments include retail natural gas at company-owned natural gas fueling stations and conversion of gasoline-fueled vehicles to hybrid (natural gas/gasoline) powered vehicles.

The following extracts relating to CNG and LNG are taken from CHNG ‘s 2010 Annual Report filed with the United States Securities and Exchange Commission (Form 10-K).

OVERVIEW

We [CHNG] are an integrated natural gas operator in the People’s Republic of China (referred to herein as China or the PRC), primarily involved in distribution of compressed natural gas, or CNG, through the CNG fueling stations owned by our variable interest entity, or VIE, Xi’an Xilan Natural Gas Co., Ltd. (referred to as XXNGC). As of December 31, 2010, our VIE operated 27 CNG fueling stations in Shaanxi Province and 12 CNG fueling stations in Henan Province. Our VIE owns our CNG fueling stations while we lease the land upon which our VIE-owned CNG fueling stations operate. For the year ended December 31, 2010, we sold 169,441,928 cubic meters of CNG through our fueling stations, compared to 164,343,895 cubic meters for the year ended December 31, 2009 [+3%].

We are pursuing multiple, synergistic paths of growth through our VIE, XXNGC, and XXNGC’s subsidiaries, all of which are based in the PRC. We intend to:

  • enter the liquefied natural gas, or LNG, business through the construction of an LNG production facility in Jingbian Country, Shaanxi Province, and LNG fueling stations in Shaanxi and Hubei Provinces;
  • capitalize on the opportunities arising from the busy shipping activities on the Yangtze River by expanding into Hubei Province through the construction of LNG fueling stations located in harbors along the Yangtze River, inland LNG fueling stations and reserve LNG stations along the course of the Yangtze River, as well as continued development of conversion technologies and operations to modify river vessels to run on a mixture of LNG and diesel; and
  • continue to grow our CNG business in Shaanxi and Henan Provinces by adding new CNG fueling stations to our network, and expanding our CNG business into Hubei Province.

CURRENT OPERATIONS

We currently operate four main business lines:

  • distribution and sales of CNG through our VIE-owned CNG fueling stations serving hybrid (natural gas/gasoline) powered vehicles (39 stations in total as of December 31, 2010);
  • installation, distribution and sales of piped natural gas to residential and commercial customers through our VIE-owned pipelines. We distributed and sold piped natural gas to approximately 115,479 residential customers as of December 31, 2010;
  • distribution and sales of gasoline through our VIE-owned CNG fueling stations for gasoline and hybrid (natural gas/gasoline) powered vehicles (four of our VIE owned CNG fueling stations sold gasoline as of December 31, 2010); and
  • conversion of gasoline-fueled vehicles to hybrid (natural gas/gasoline) powered vehicles at our automobile conversion workshops.

We purchase all of the natural gas that we sell and distribute to our customers from our suppliers. We are not involved in the mining or production of natural gas. We currently sell our natural gas in two forms: (i) CNG and (ii) piped natural gas.

RECENT DEVELOPMENTS

LNG Business

On September 2, 2010, we announced the completion of our first LNG fueling station. The station is located in Hongqing District, Xi’an, and we believe it is the first LNG fueling station in Shaanxi Province. The LNG fueling station will initially serve as a working model to showcase the market potential of LNG to future users rather than to generate revenues.

On June 30, 2010, we commenced the test run of Phase I of our LNG plant in Jingbian County, Shaanxi Province, which, when operational, will have a processing capacity of 500,000 cubic meters per day, or approximately 150 million cubic meters on an annual basis.

In addition, as of December 31, 2010, we had invested $35.9 million for the construction of phases II and III of Jingbian LNG plant. We currently estimate that an investment in phases II and III of $206.9 million through December 2015 would be needed to finance the construction of a processing capacity of 3,000,000 cubic meters of LNG per day, or approximately 900 million cubic meters per year. However, we have not made a final determination on the processing capacity for phases II and III.

At present, the Jingbian LNG plant has completed several test runs and is under preparation for production. The launch of the operations of the plant will serve as a precursor to our backward and forward integration strategies, which involve the development of our own network of LNG fueling stations in Shaanxi and Hubei Provinces.

Hubei Province and Yangtze River

In April 2010, we received the approval from local government authorities in Hubei Province to build inland LNG fueling stations, LNG fueling stations in harbors along the Yangtze River and reserve LNG stations. In addition, during the third quarter of 2010, we completed the acquisition of Hanchun Makou Yuntong Compressed Natural Gas Co., Ltd., or Makou, for a purchase price of $3,648,080. Makou owns and operates a CNG compressor station in Hanchuan City, Hubei Province, and purchases natural gas through pipelines, conducts compressing and sells natural gas on a wholesale basis through tankers to fueling stations in Hubei Province. We believe that the Makou acquisition laid the foundation for expanding our CNG business into Hubei Province. Makou’s compressor station currently has sufficient capacity to process 80,000 to 100,000 cubic meters of natural gas daily and is advantageously located near railways and arterial highways.

We are also seeking to develop the market demand for natural gas in the Yangtze River shipping industry by leveraging our automobile conversion know-how to develop conversion technologies and operations to modify river vessels to be powered by a mixture of LNG and diesel. In August 2010, a tugboat modified by us to operate on a mixture consisting of 70% LNG and 30% diesel completed its maiden voyage on the Yangtze River, which we believe was the first time that an LNG-powered ship navigated China’s domestic waterways.

Shaanxi and Henan Provinces

During the second quarter of 2010, XXNGC effectively acquired 100% of the assets and operating rights of four CNG fueling stations in Xi’an, Shaanxi Province, for an aggregate cash consideration of $10,502,490. During the third quarter of 2010, we closed one CNG fueling station in Shaanxi Province because the local government pulled down the district where the station was located for reconstruction. As a result, as of December 31, 2010, XXNGC operated 27 CNG fueling stations in Shaanxi Province and 12 CNG fueling stations in Henan Province.

SIGNIFICANT FACTORS AFFECTING OUR RESULTS OF OPERATIONS ARE:

Successful expansion of our CNG business.  Our revenue increased by 11.0% during the year ended December 31, 2010 from the year ended December 31, 2009, largely due to increased CNG sales driven by the addition of four new CNG fueling stations in Xi’an in the second quarter of 2010 and one new CNG fueling station in Xi’an in the third quarter of 2009, and larger piped natural revenue as a result of our acquisition of Makou in the third quarter of 2010. As of December 31, 2010, we operated 39 CNG fueling stations in total, with 27 CNG fueling stations in Shaanxi Province alone.

The successful expansion of our CNG fueling station business in Xi’an and Henan Province has been a significant factor driving our revenue growth and results of operations for 2010. While we intend to expand into different provinces, we anticipate the growth of our CNG fueling business in Xi’an and Henan Province will continue to significantly affect our results of operations as we intend to continue to increase the number of CNG fueling stations we operate in these areas.

CNG conversion center

Government policies encouraging the adoption of cleaner burning fuels.  Our results of operations for the periods covered by this report have benefited from environmental regulations and programs in the PRC that promote the use of cleaner burning fuels, including natural gas, for vehicles. As an enterprise engaged in the natural gas industry, our VIE, XXNGC, benefits from a reduced income tax rate of 15% compared to the standard 25% enterprise income tax rate in the PRC.

In addition, the PRC government has encouraged companies to invest in and build the necessary transportation, distribution and sales infrastructure for natural gas in various policy pronouncements such as by officially including CNG/gasoline hybrid vehicles in the country’s “encouraged development” category. These policies have benefited our results of operations by encouraging the demand for our natural gas products and also by lowering our expenses.

As we plan to expand into the LNG business, we anticipate that our results of operations will continue to be affected by government policies encouraging the adoption of cleaner burning fuels and the increased adoption of CNG and LNG technologies.

Natural Gas from Fueling Stations.  Natural gas revenue from our fueling stations increased by 10.2%, or $6,027,261, to $65,285,236 during the year ended December 31, 2010, from $59,257,975 during the year ended December 31, 2009, and contributed 72.6% of our total revenue, the largest of our four major business lines. The increase in natural gas revenue was primarily due to the addition of four new fueling stations during the second quarter of 2010 and one new fueling station in the third quarter of 2009, offset by the one fueling station closed during the third quarter of 2010.

During the year ended December 31, 2010, unit selling price was $0.37 (RMB 2.48) and $0.44 (RMB 2.98) net of VAT in Shaanxi and Henan Provinces, respectively, or $0.39 (RMB 2.64) on an average basis, compared to $0.34 (RMB 2.33) and $0.41 (RMB 2.83) net of VAT in Shaanxi Province and Henan Province, respectively, or $0.37 (RMB 2.5) on an average basis during the year ended December 31, 2009.

Automobile Conversion Services.  Revenue from our automobile conversion division decreased by 38.4%, or $1,001,325, to $1,605,467 during the year ended December 31, 2010 from $2,606,792 during the year ended December 31, 2009, and contributed 1.8% of our total revenue.  We believe that the decrease was primarily due to an increasing percentage of CNG vehicles having already undergone conversion, as well as increased market competition.

(This article compiled using information from China Natural Gas, Inc.)

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