Investing In China's Oil And Gas Sector With This Non-Government Entity

| About: Longwei Petroleum (LPIH)

Much of the investment capital flowing into China's energy sector has gone to the large state-owned oil and gas companies such as PetroChina (NYSE:PTR), CNOOC (NYSE:CEO), and Sinopec (NYSE:SHI). With state-controlled entities being seen as the stable enterprises that have been blessed to work with a free administrative hand when it comes to their operations, these three large corporate powers have grown quickly into titans of their field. Yet there exists many non-government entities that continue to grow at exponential rates in light of China's booming economy.

As one of the few Chinese companies publicly traded in the United States that operates in the realm of energy distribution in China, Longwei Petroleum (LPH) stands as one of the largest oil and gas distributors in the Shanxi Province. The company is one of five such distributors in Shanxi, and operates with the largest storage capacity of any non-government entity in Shanxi. It purchases diesel, gasoline, fuel oil, and kerosene from a variety of petroleum refineries in the People's Republic of China. The following picture is a look at their two facilities in Gujiao and Taiyuan that equate to their storage capacity a combined 120,000 MT.

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However, one glance at the company's stock charts and a passing investor would easily question the performance of the company's business in light of the stock volatility. It's unfortunate that such trepidation is not unwarranted. Longwei Petroleum gained access to the domestic US markets by first listing its stock on the over-the-counter bulletin board (OTC:BB) having undergone a reverse merger with a shell company. The company then sorted itself out to fall into accordance with all the uplisting requirements and now trades on the AMEX thereby completing a backdoor process known as a reverse merger and skirting the need for an expensive IPO. Yet here is where the fears arise.

Over the last two years, the U.S. financial markets were seemingly attacked by a wave of fraudulent Chinese reverse mergers that claimed the capital of both American and Chinese investors alike. Exposed practices of poor internal management, falsified documentation, shameful auditing, and reporting contradictions all helped to show the huge difference in how business is run in both China and the United States. Yet over the past half year, the alarming news of fraudulence and other corporate scandals from the small-cap Chinese sector has slowed to a crawl. Perhaps as it stands now, investors willing to gamble on the surviving reverse mergers may find that these entities have been refined by fire under intense scrutiny and have deservedly passed the test of validation.

While the haziness of the poor market sentiment continues to linger, what remains clear is that the domestically traded Chinese small-cap market has not come close to recovering in a manner reflected by the financials they bear. As it stands, Longwei Petroleum trades with a price-to-book ratio of 0.58 and a trailing price-to-earnings ratio of 2.17 as of March 24, 2012. All this comes on the heels of the company's ongoing success in capitalizing on its leading position as a petroleum-based distributor in a very niche industry with high barriers to entry. Though having the ability to further dilute its investment base in order to move forward with ongoing acquisition plans, the company has seemingly shown restraint in such efforts - an encouraging sign of respect for the shareholders.

Quite unique to the Chinese sector, the company has even begun to express a more conciliatory tone when it comes to addressing the needs of investors in light of the poor sentiment faced across the board. On March 15, Longwei stated it would essentially conduct independent evaluations in a review of the company's filing validity. It also expressed interest in a campaign intentioned for restoring investor confidence - a move that might soon be echoed by other Chinese companies.

With easily proven assets and infrastructure that retain much of the company's declared value, it's hard to believe that there resides so much doubt over a thriving company tackling one of China's growing and restricted industries found in energy distribution. In regards to Longwei's larger facility based in Gujiao, the company has no significant competitors in non-government operated fuel wholesalers. In Taiyuan, there are only two such competitors. Above all, Longwei has time and time again stressed the importance of its two "Finish Oil Wholesale Licenses" and two "Dangerous Chemical Products Business Licenses," which both allow for product distribution across the PRC and have been proven to be difficult to obtain by those seeking to enter into the business.

From a macro perspective, the need for China to build efficient energy distribution infrastructure has only served to help Longwei's daily operations. The lack of a pipeline in the vicinity of the company's businesses has helped to create an extreme competitive advantage. Storage capacity and solid supply chains appear to be of greater value to customers than keeping costs low. This is especially the case in a China whose industrial output has seen dramatic double digit growth year over year. It would appear that Longwei is well situated from a fundamental business standpoint even if the markets continue to discount the company out of fear.

Disclosure: I am long LPH, SHI.