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 December 12, 2017
What's that burning? $58 billion for Beijing's clean air

 The Asian Infrastructure Investment Bank, conceived as China's answer to the World Bank, approved a $250 million loan to Beijing Gas Group Co., to reduce coal use by connecting more than 200,000 rural households to the natural gas distribution network. It's the AIIB's first investment within China.

The bank had better keep its checkbook handy: This new environmental protection drive could cost the Chinese government and its financing vehicles as much as 381 billion yuan ($57.6 billion) in subsidies.

Authorities have realized that persuading villagers to stop burning coal is a more effective way of improving air quality in northern China than shutting coal-powered plants, a step that inevitably hurts economic growth.

Chinese farmers use scattered coal for heating in the winter, and this low-quality fuel is five to 10 times more dirty than variants burned in factories, according to Morgan Stanley. Scattered coal accounts for only 10 percent of total coal consumption in the Beijing-Tianjin-Hebei region but more than 50 percent of airborne pollutants, according to a Dec. 9 editorial in the People's Daily.

Earlier this year, China launched a "2+26 cities" initiative, aiming to reduce air pollution in Beijing, Tianjin and 26 smaller cities in the surrounding Hebei, Shandong, Shanxi and Henan provinces. The group includes 65 percent of China's most polluted cities.

For 2017, the government aims to connect 3.5 million rural households in the region to gas pipelines. The total number could reach 37 million, estimates Morgan Stanley analysts Joseph Lam and Simon Lee.

To get villagers off scattered coal, China is prepared to pay. Gas distributors can receive as much as 10,300 yuan per household, including 4,000 yuan for connection fees, 2,700 yuan for the gas heater, and up to 1,200 yuan per year in winter gas subsidies for as long as three years. Based on Morgan Stanley's estimate of 37 million rural households, that would mean potentially 381 billion yuan in total subsidies.

The stock market has already caught wind of this new cash cow. China Gas Holdings Ltd., the most aggressive operator, has rallied 127 percent this year, ENN Energy Holdings Ltd. has jumped 76 percent and China Resources Gas Group Ltd. has climbed 34 percent.

China Gas aims to add as many as 1 million households to its network this year, followed by a further 2 million in 2018 and 2.5 million in 2019, more than its competitors combined. Not surprisingly, sell-side analysts are forecasting faster earnings growth.

Hooking up new customers is a lucrative business. In the half-year through September, China Gas reported a 68 percent profit margin on connection fees, against an overall margin of 26.2 percent.

But as always, big ambition comes with big risks. Analysts are concerned that gas distributors won't get paid promptly. In general, it takes the government six to nine months to disburse connection fees.

So far, China Gas's ability to collect cash from the government -- as measured in days sales outstanding -- hasn't deteriorated. But the worry is there, especially as China Gas is now trading at a multiple of 13.5 times enterprise value to Ebitda, 21 percent more expensive than its peers.

There's also the question of whether China will stick to its ambitious plan. The government recently stepped back and allowed some regions to revert to burning coal to keep people warm. The cost is also climbing as demand soars: Natural gas prices jumped by 28 percent in one week to 5,636.7 yuan per ton at the end of November.

Getting the AIIB in the game is perhaps Beijing's way of saying that 2+26 cities is here to stay. Just keep that checkbook ready.