2nd largest LPG importer in China. We recently visited Ouhua Energy?s (OE) plant in Chaozhou City, China. OE is a licensed tier-one LPG distributor that imports raw materials such as butane and propane from Middle-Eastern suppliers and processes them into liquefied petroleum gas (LPG) for sale to customers across China. OE is currently the 2nd largest importer in terms of quantity of LPG in China, up from its previous ranking of 3rd largest in FY05, thanks to rising domestic demand and an increase in capacity.

50% increase in production capacity from FY06. At OE?s plant, we were given a tour of their operations. To meet increasing market demand, OE has invested RMB32m in a refrigerated storage tank (operational since Oct 2006) to increase its annual production capacity of 600,000 tonnes in early 2006 by 50% to 900,000 tonnes currently. We understand that the plant is already running at 91% utilization rate and OE plans to increase its production capacity to 1m tonnes by end 2007. Management expects to see the full impact and benefits of this increase in capacity being reflected in FY07.

Research to combat rising COGS. Between 2003 and 2006, the prices of butane and propane have risen by 70.5% due to increasing demand, but OE has been successful in passing on these cost increases to its customers, as reflected by the 73.1% increase in LPG?s selling price over the corresponding period. To protect margins in the long run, OE?s sister company is carrying out research on adding Dimethyl-Ether (DME) to LPG. If successful, the cost of raw materials would be lowered, thereby boosting gross margin. However, management did not specify the timeline for the completion for the project nor quantify the potential financial impact of the project?s success on OE.

LPG prospects still burning bright. With China searching for more efficient fuels to meet its immense energy needs, there should be a strengthening of domestic demand for LPG due to its portability, efficiency, cleanliness and convenience. This bodes well for OE although management has yet to specify any plans to increase its production capacity beyond 2007. Instead, OE intends to focus on margin expansion through the DME project. We do not have a rating on the stock.