China Oil and Gas:Converting Coal

China’s coal conversion business has to date suffered from policyuncertainties and unsuccessful pilot projects. However, we are nowbullish on China’s coal to synthetic gas business on more supportivepolicy, better economics through higher gas prices and soft coal price ,and shortages of natural gas suply. Water consumption will be less of aconstraint than many investors think. We believe Sinopec will take a leadand their EPC business SEG will benefit from the investment cycle.

Coal to synthetic gas in favour。

The economics of coal to chemical business varies by final product, process andengineering techniques, feedstock cost, etc.

Overall, we favour coal to gas v’s coal to olefins or coal to liquids, on bettereconomics, less water consumption, less pollution, and most importantly, thescarcity of gas in China.

Our CRR team just conducted a survey on China’s coal to gas and supported ourview that the sector is moving into the fast lane.

Benefits from pipeline open access。

Pipeline access used to be a significant constraint for remotely located coal to gasprojects, which are almost exclusively in Xinjiang and Inner Mongolia.

Sinopec is building its Xinjiang-Guangdong-Zhejiang coal to gas pipeline with totalcapacity 30bcm, and will open its access to other coal to gas projects in Xinjiang.

Also, PetroChina is opening up its WEP 1&2 (also WEP3 once it’s completed) forpublic access, which will benefit Xinjiang’s coal to gas projects.

Water consumption in control。

Water consumption and pollution has for long been a concern for investors overChina’s coal to chemical business.

Water consumption by coal to gas projects actually comes in much lower thanmaking paper and steel, and in par with textile.

Supported by our CRR survey, water consumption is less a constraint on the projectthan people thought.

EPC contractors such as SEG are the biggest beneficiaryq Sinopec (386 HK – UPF), rather than coal producers, will take the lead in China’scoal to SNG business as they have an edge in coal conversion techniques and ownthe pipelines.

SEG (2386 HK – BUY) will be one of the biggest beneficiary of China’s coal to gasprojects