We were incorporated in the state of Delaware on March 31, 1999, as Bullet Environmental Systems, Inc. On May 25, 2000 we changed our name to Liquidpure Corp. and on February 14, 2002 we changed our name to Coventure International, Inc.
On December 6, 2005, we issued an aggregate of 4 million shares to all of the registered shareholders of Xi’an Xilan Natural Gas Co., Ltd., and entered into exclusive arrangements with Xi’an Xilan Natural Gas Co., Ltd. and these shareholders that give us the ability to substantially influence Xi’an Xilan Natural Gas’ daily operations and financial affairs, appoint its senior executives and approve all matters requiring shareholder approval. On December 19, 2005, we changed our name to China Natural Gas, Inc.
On February 21, 2006, we formed Xilan Natural Gas Equipment Ltd., ("Xilan Equipment") as a wholly owned foreign enterprise (WOFE). We then, through Xilan Equipment, entered into exclusive arrangements with Xi’an Xilan Natural Gas Co., Ltd. and these shareholders that give us the ability to substantially influence Xi’an Xilan Natural Gas’ daily operations and financial affairs, appoint its senior executives and approve all matters requiring shareholder approval. We memorialized these arrangements on August 17, 2007. As a result, the Company consolidates the financial results of Xi’an Xilan Natural Gas as variable interest entity pursuant to FASB Interpretation No. 46R, "Consolidation of Variable Interest Entities."
We distribute and sell natural gas to commercial, industrial and residential customers in the Xi’an area, including Lantian County and the Lintong and Baqiao Districts, of Shaanxi province of The Peoples' Republic of China ("China" or the "PRC") through a network of approximately 120 km of high pressure pipelines. We also distribute and sell CNG as vehicular fuel through a network of CNG fueling stations in Shaanxi and Henan Provinces. As of December 31, 2008, we owned and operated 23 CNG fueling stations in Shaanxi Province and 12 CNG fueling stations in Henan Province.
We operate four primary business lines:
Distribution and sale of compressed natural gas (CNG) through Company-owned CNG fueling stations for hybrid (natural gas/gasoline) powered vehicles (35 stations as of December 31, 2008);
Installation, distribution and sale of piped natural gas to residential, commercial and industrial customers through Company-owned pipelines. The Company distributes and sells natural gas to approximately 96,033 homes and businesses as of December 31, 2008;
Distribution and sale of gasoline through using Company-owned CNG fueling stations for hybrid(natural gas/gasoline) powered vehicles( 5 gasoline selling stations by December 31, 2008), and Conversion of gasoline-fueled vehicles to hybrid (natural gas/gasoline) powered vehicles at our Auto Conversion Division.
We buy all of the natural gas that we sell and distribute to our customers from government owned enterprises and private sources. We do not mine or produce any of our own natural gas and have no plans to do so during the next 12 months. The natural gas that we buy is available in two forms: (i) piped natural gas; and (ii) CNG. In 2008, the Company entered into multiple agreements to purchase compressed natural gas of about 160,696,901 cubic meters.
Commitments and Contingencies
The Company has existing long-term natural gas purchase agreements with its major suppliers. However, none of those agreements stipulate any specific purchase amount or quota each year, thus giving the Company flexibility to constantly look for lower-cost source of natural gas supply. Therefore, the Company is not legally bound in purchase commitments by those agreements.
Our Products, Services and Customers
Our Pipeline Distribution System
We own and operate a network of approximately 120 km of high pressure pipeline in the Xi’an area. The network connects to a high pressure pipeline network of the government operated Shaanxi Natural Gas Company, which supplies natural gas directly from a gas field in the northern region of the province. Our high pressure pipeline then feed into city-gate "let-down" stations at Hongqing and Lantian County, where the pressure is reduced and natural gas is transported through a network of low-pressure distribution pipes to supply our residential, commercial and industrial customers in Lantian County and the Lintong and Baqiao Districts. The spur also feeds our compressor station at Hongqing and Xianyan where CNG is collected by tankers to supply CNG fueling stations.
Each of our pipeline customers is physically connected to our pipeline network through Company installed and maintained connection equipment and natural gas usage monitoring systems, from which we generate additional revenues.
We believe that we are currently the sole authorized provider of natural gas to residential customers in our service area and the only privately owned company in the Shaanxi province to own and operate this type of high pressure pipeline.
CNG Fueling Stations
As of December 31, 2008, we own and operate 23 CNG natural gas fueling stations in the Xi’an metropolitan area and 12 natural gas fueling stations in Henan province. Through these company-owned fueling stations, CNG is sold to taxis, buses and private cars that operate on CNG technology. Currently, we purchase natural gas for 1.22 RMB/cubic meter and sell each cubic meter for 2.35 RMB net of value added taxes in Shannxi province.
We continue expanding our CNG fueling station base by constructing new stations as well as acquiring existing stations. We can construct a CNG fueling station in approximately 60 days for a cost of approximately US$900,000. We are evaluating additional sites for CNG fueling stations in Xi’an and in other regions such as Henan province.
The Company also owns three compressor stations: two located in Xi’an: Hongqing station, acquired in July 2005, near our pipeline; Changsheng station, acquired in September 2008; and the other one in Xianyang city, acquired in January 2008. A compressor station compresses natural gas and allows trucks to transport CNG to fueling stations. The Company currently has the daily processing capacity of 250,000 cubic meters of CNG.
Our Liquefied Natural Gas (LNG) Project
During 2008, we made significant progress to move into the processing, distribution and sale of LNG. The Company spent about $20 million in the LNG project during 2008, including technology licensing fees, prepayment of equipment purchases, land requisition, and other constructions. We plan to raise the remaining $20 million investment from our cash reverve, internal operating cash flow, prepayments from our customers, and credit facility from Chinese commercial banks. We believe that adding LNG to our product offerings will expand our geographic sales footprint and improve revenues and profitability. The facility construction work is expected to be completed around June, 2009, and processing equipment installation and testing will be finished by October, 2009. So far the project is on schedule for commercial operation towards the end of 2009.
Both CNG and LNG are natural gas compressed into canisters for convenient transportation, usually by tank trucks, to locations of distribution or consumption. Typically CNG is compressed at 200 times atmospheric pressure and can be transported at normal temperatures to distances of up to 300 kilometers. LNG is compressed at up to 625 times atmospheric pressure and must be transported at sub-zero degree temperatures. The cost of compressing and processing LNG is higher than those of CNG, but LNG can be transported over longer distance and per unit transportation costs are therefore lower.
In September 2007 we have started the construction of an LNG processing and distribution plant in Jingbian, Shaanxi province (the "LNG Project"). We estimate that the LNG Project will cost approximately $40 million (RMB 309 million). As of March 10, 2008, we have secured such financing and we believe that the plant can be completed by 2009. We have obtained the required permits and approvals to build the LNG plant from local government authorities.
The approval process for LNG plant construction of this type is lengthy and arduous—a factor which we believe is a significant barrier to entry to potential competitors and which better positions our company for long-term growth. This project also allows us to diversify our business and focus on two high-growth areas: CNG fueling station business and LNG production, distribution, and sale. We believe that the PRC's clean energy policies will bolster demand for natural gas in China and we have government support to be a leader in this area.
Our CNG Market
We estimate that currently there are approximately 50,000 vehicles using CNG in the Xi’an area. Currently it is estimated that there are 6,000 buses and 20,000 taxis using CNG in Xi’an. Each bus uses an average of 100 cubic meters of CNG per day and taxis use an average of 40 cubic meters of CNG per day (Source: Xi’an Clean Fuel Vehicles Commission 2007) The PRC government estimates in its Eleventh Five Year Plan (2006-2010) that current total demand for CNG as a vehicular fuel in the Xi’an area is approximately 1,070,000 cubic meters per day. Compared to gasoline and diesel, natural gas as vehicular fuel is cheaper, cleaner and safer. The PRC government’s Clean Energy Policy encourages the use of CNG as a vehicular fuel.
We estimate that the average CNG station in Xi’an pumps approximately 15,000 cubic meters of CNG per day. In the end of 2008, there were 64 CNG fueling stations in Xi’an. We estimate that approximately 940,500 cubic meters of CNG is pumped per day during the year, a figure well below estimated total demand. As a result, we believe that there is significant unmet demand for CNG as vehicular fuel in the Xi’an area that provides us great opportunities for profit and growth.
We believe that our vertically integrated operations, proprietary pipeline and secured supply contracts give us greater access to CNG supplies and customers and a unique competitive position as a major supplier of CNG vehicular fuel in the Xi’an area.
Our Pipeline Network Customers
As of December 31, 2008 we had approximately 96,033 customers, including residential, industrial and commercial customers. We are continuing to expand our customer base in Xi’an's newly developed business and residential areas including Xihan and Chanliu. Our industrial customers, including the Xiwei Aluminum Company and the Hungtian Company, use natural gas as a raw material for their production process. We are not dependent upon any single customer or group of customers for a material portion of our natural gas sales or revenues.
Our pipeline customers purchase natural gas by prepaid cards that can be inserted into the connection equipment to initiate gas flow.
The Company entered into agreements with Xi’an International Port Administrative Committee and the Town of Tangyu in April and October 2008, respectively, to provide natural gas to local residents and businesses on an exclusive basis. The international Port project is estimated to involve the development of approximately 13.5 square miles of business district and the investment of up to $30 million over the next several years, based on the Port Committee’s planning schedule. The Tangyu project involves supplying natural gas to potentially 50,000 residential and commercial users of this well-known tourist attraction.
Our Subsidiaries and Variable Interest Entities
On October 24, 2006, Xi’an Xilan Natural Gas formed a wholly-owned subsidiary, Shaanxi Jingbian Liquefied Natural Gas Co., Ltd., a limited liability company organized under the laws of the PRC to administer the production and sales of LNG.
In 2006, Xi’an Xilan Natural Gas, through its wholly-owned subsidiary, Shaanxi Jingbian Liquefied Natural Gas Co., Ltd, received a letter from PetroChina Company Limited pursuant to which PetroChina agreed in principle, subject to the negotiation and execution of a final contract, to supply up to 150,000,000 cubic meters of natural gas annually upon the completion of our LNG project.
In 2006, we formed a wholly-owned subsidiary, Xi’an Xilan Natural Gas Equipment Ltd., a limited liability company organized under the laws of the PRC (“Xilan Equipment”), to provide equipment to our own CNG fueling stations.
Effective March 8, 2006, we also established a variable interest entity, Xi’an Xilan Natural Gas by entering into exclusive arrangement with Xi’an Xilan Natural Gas through our subsidiary Xilan Equipment. Pursuant to the exclusive arrangement, the Company, through Xilan Equipment, has the ability to substantially influence Xi’an Xilan Natural Gas’ daily operations and financial affairs, appoint its senior executives and approve all matters requiring shareholder approval. As a result, based on FASB Interpretation No. 46R, Consolidation of Variable Interest Entities, the Company is able to treat Xi’an Xilan Natural Gas as a variable interest entity of the Company and consolidate its financial results.
In May 2007, Xi’an Xilan Natural Gas formed a wholly-owned subsidiary, Xi’an Xilan Auto Body Shop.
In December 2008, we completed 100% acquisition of Henan Lingbao Yuxi Natural Gas Limited which owns exclusive operation right to supply natural gas to the city of Lingbao for residential, industrial, commercial and vehecular uses. According to the official website of Lingbao Municipal Government (www.lbwbw.com), the City has a total population of about 800,000 among which 200,000 are urban residents and 600,000 are countryside residents. There are about 80,000 urban households, and an estimated annual consumption of natural gas of 20,000,000 cubic meters.
The Company purchases all of the natural gas for resale mainly from four vendors, PetroChina Changqing Oilfield Company, Jiyuan Yuhai Natural Company, Shaanxi Natural Gas Co. Ltd., and Jingcheng City Mingshi Coal Bed Methane Exploitage Ltd. The Company has long-term supply agreements with PetroChina Changqing Oilfield Company and Jingcheng City Mingshi Coal Bed Methane Exploitage Ltd. with no minimum purchase requirements. The price of natural gas is strictly controlled by the government and has remained stable over the past 3 years.
On October 19, 2006, we received a letter from PetroChina Company Limited pursuant to which PetroChina agreed in principle to supply up to 150 million cubic meters of natural gas annually to our subsidiary subject to the negotiation of a final agreement once our LNG plant is built.
According to the general business practices of PetroChina, the above-mentioned approval of 150 million cubic meters’ annual supply quota should ensure our LNG project the amount of annual supply from PetroChina’s wholly-owned subsidiary Changqing Oil Field Group Limited which has a 14 billion-cubic-meter natural gas purification facility next door to our LNG project. The supply agreement for 2009 will be based on our LNG plant’s expected processing capability for this year and will be entered between the company and Changqing Oil Field Group Limited around third quarter of this year because once the supply amount is stipulated in the agreement, the company would need to pay full fee for the amount no matter we could use them or not.
We do not expect any difficulty in continuing to renew our supply contracts during the next 12 months.
PRC Natural Gas Industry Overview
China's rapidly expanding economy is stretching the limits of its energy resources. The country is the world’s second largest energy consumer after the United States, with an annual energy consumption growth rate as high as 12.8% between 2002 and 2006 and slowed down slightly to 10.8% between 2006-2008 due to Chinese government’s national policy of “saving energy and reducing emission”. During the same period, natural gas consumption grows at 13.3% annually. Natural gas currently accounts for only 3% of the country’s total energy usage, compared to the world average 23%.
According to China’s Ministry of Science & Technology and World Petrolium Council’s China Committee’s 2009 report, for the next 20 years, China’s energy consumption elasticity index remains at 0.45-0.50, among which coal is 0.30, petrolium is 0.50, natural gas is 1.4-1.5, and non-renewable electricity is 0.50-0.60. China’s natural gas represents the fastest-growing energy source. With the operation of China’s West-East Natural Gas Pipeline” project, it is estimated that China’s natural gas consumption grows at 15% per year and will reach a volume of 100 billion cubic meters in 2010, representing 400%-500% growth over 2000.
China’s 11th Five-Year Plan (2006-2010) has made the development of natural gas engine for heavy-load trucks as a national key development project, demonstrating Chinese central government’s decision to reply on natural gas as a major alternate fuel source for high-consumption vehicles.
In order to meet the demand for natural gas, the PRC government has encouraged private companies to invest in and build the necessary transportation, distribution and sale infrastructure for natural gas. On February 24, 2005, China’s State Council issued an opinion encouraging and supporting private sectors to get involved into industries that were previously monopolized by state-owned enterprises only. Those industries open to private sectors include oil and natural gas distribution. The opinion provided a legal framework for private urban natural gas distribution.
Sources of Energy
Traditionally, the PRC has relied heavily on coal and crude oil as its primary energy sources. According to China Statistical Yearbook, in 2006, coal, crude oil, hydro-electricity and natural gas accounted for 69.40%, 20.40%, 7.20% and 3.00%, respectively, of the PRC's total energy consumption. During the PRC government’s Eleventh Five Year Plan (2006-2010), the percentage of coal, crude oil and hydro-electricity would go down to 66.1%, 20.5% and 6.8% respectively, while that of natural gas would increase to 5.1%. Traditionally, a large portion of natural gas is consumed as raw material for production of fertilizer. A little over 10% of natural gas is consumed as fuel. (Source: The Institute of Energy Economics of Japan).
The PRC's heavy reliance on coal exceeds world consumption rates for the same period, which was 22.2% (Source: Energy Information Administration, U.S. Department of Energy). The use of coal, however, causes air pollution and other negative consequences to the environment. In the PRC, the heavy use of unwashed coal has led to large emissions of sulfur dioxide and particulate matter. An air pollution study conducted by the World Health Organization in 2006 showed that seven of the 10 most polluted cities in the world were located in the PRC. As such, there have been serious environmental concerns in many countries around the world, resulting in a global trend to reduce coal usage. In consideration of such trends, in 2006, the PRC presented a plan to raise the share of natural gas in the country's energy mix (Source: 11th Five-Year Plan (2006-2010)). In many locations where natural gas supply is available, local governments often require all new residential buildings to install piped gas connections as a condition to the issuance of the construction or occupancy permits. Before 2006, local municipal governments controlled gas distribution. Since then, the industry has been opened to private companies, whose investments have fostered an increase in the use of natural gas in the PRC. The PRC government has deemed the natural gas industry a suitable industry for public and private investments.