Worlwide Meoh Consumption

Chinese Shipyard Sector 57

15 December 2011 Initiate Coverage

C H I N A B L U E C H E M I C A L

Cost-efficient Fertiliser Play Eyes Upstream Expansion

China BlueChemical (China BlueChem) is one of the largest and most efficient nitrogen fertiliser producers in terms of production volume and energy consumption in China. Its core business is the production and sales of urea, the most commonly used nitrogen fertiliser in China. Besides, the company also produces phosphate fertilisers, methanol and Polyoxymethylene (POM). It is one of the major subsidiaries of CNOOC, the third largest petroleum company in China.

Cost-efficient. China BlueChem’s 1H11 net profit increased 93% yoy, significantly higher than its peers. This is largely due to its unique position in sourcing raw materials. It purchases natural gas from its parent company CNOOC at lower-than-market prices and is perfectly shielded from cost pressures. China BlueChem also enjoys lower transportation costs as it is the controlling shareholder of Hainan Basuo Port Company. The port has been playing an important role in transporting China BlueChem’s products.

Efficient management and impressive execution ability. With regard to expansion plans and new projects, management has always been able to meet its guidance. So far, the new projects are going well as planned, which reflects well on its execution ability.

Methanol M15 standard to serve as an earnings growth catalyst. Once the M15 standard is released, its market application will be fast and prompt prices to go up. With an annual production capacity of 1.6m tonnes of methanol, China BlueChem will be a major beneficiary.

Major capacity expansion plans. China BlueChem has announced its plans to more than double its production capacity in the next five years, from 4m tonnes per year to 8.3m tonnes per year.

Initiate coverage with BUY and target price of HK$7.30.

Key Financials

Year to 31 Dec (Rmbm) 2009 2010 2011F 2012F 2013F

Net turnover 5,795 6,867 9,645 11,317 13,174 EBITDA 2,012 2,434 3,947 4,400 5,017 Operating profit 1,283 1,691 2,793 3,093 3,542 Net profit (rep./act.) 985 1,175 2,019 2,137 2,348 Net profit (adj.) 985 1,175 2,019 2,137 2,348 EPS (Fen) 21.4 25.5 43.8 46.4 50.9 PE (x) 22.7 19.0 11.1 10.5 9.5 P/B (x) 2.3 2.1 1.8 1.6 1.4 EV/EBITDA (x) 11.0 9.1 5.6 5.0 4.4 Dividend yield (%) 2.0 1.4 2.5 2.7 2.9 Net margin (%) 17.0 17.1 20.9 18.9 17.8 Net debt/(cash) to equity (%) (20.1) (19.4) (13.4) (14.8) (16.7) Interest cover (x) 432.4 451.9 323.7 291.6 279.2 ROE (%) 10.3 11.6 17.8 17.6 16.1 Consensus net profit - - 1,960 2,239 2,570 UOBKH/Consensus (x) - - 1.03 0.95 0.91

n.m.: not meaningful; negative P/E, EV/EBITDA reflected as "n.m." Source: China BlueChemical, Bloomberg, UOB Kay Hian

Refer to last page for important disclosures.

C H I N A

BUY

Share Price HK$5.93 Target Price HK$7.30 Upside +23.1%

Company Description The company mainly manufactures, develops and sells urea, phosphate and synthetic chemical products with natural gas as the raw material.

Stock Data GICS sector MaterialsBloomberg ticker: 3983 HKShares issued (m): 1,771.0 Market cap (HK$m): 27,337.3 Market cap (US$m): 3,512.9 3-mth avg daily t'over (US$m): 4.1

Price Performance (%) 52-week high/low HK$7.13/HK$5.05

1mth 3mth 6mth 1yr YTD (5.1) (2.6) (2.5) 2.4 6.5 Major Shareholders %CNOOC 61.0

FY11NAV/Share (Rmb) 2.63 FY11 Net Debt/Share (Rmb) 0.35 Price Chart

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(%)(lcy)CHINA BLUECHEMICAL LTD - H

China Bluechemical Ltd - H/HSI Index

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Source: Bloomberg

Analyst

Wang Ao Chao +8621 5404 7225 ext 802 [email protected]

Greater China Research Team

+8621 5404 7225

China BlueChemical 2

Contents Investment Highlights.............................................................................. 3 Valuation .................................................................................................. 5 Financials.................................................................................................. 9 Industry Outlook ................................................................................... 10 Company Background........................................................................... 26 Risk Factors............................................................................................ 35 Financial Statements.............................................................................. 36

This report uses the closing prices of 14 December 2011


Investment Highlights

Cost-efficient. China BlueChem purchases natural gas from its parent company CNOOC at lower-than-market prices and is perfectly shielded from cost pressures. It is believed that the higher the inflation, the larger China BlueChem’s advantage. For instance, in 1H11, China BlueChem reported 1H11 net profit of Rmb1.0b, up 93% yoy. While strong market demand has prompted both sales volume and prices to rise, China BlueChem’s profit increased more than its peers amid higher costs of raw material costs (mainly coal). China BlueChem also enjoys lower transport costs as it owns more than 90% of Hainan Basuo Port Company. The port has been playing an important role in transporting China BlueChem’s products. It is located in Dongfang City, near China BlueChem’s production facilities. It is engaged in navigation trade with many domestic ports and over 20 countries and regions in the world. Efficient management and impressive execution ability. With regard to the expansion plans and new projects, management has always been able to meet their guidance. So far, the new projects are going well as planned, which reflects well on its execution ability. Thus, it is believed that the company has the capabilities to realise plans for fast growth. Figure 1: Utilisation And Sales-to-Production Rate

Year 2006 2007 2008 2009 2010

Utilisation rate (%) 106.1 102.2 90.4 92.5 96.9

Sales-to-production rate (%) 101.1 100.6 92.5 103.1 101.9

Source: China BlueChem Methanol M15 standard to serve as earnings growth catalyst. As a cheaper and cleaner source of energy, methanol is increasingly used in automobile fuel blending. After the Methanol Gasoline (M85) for Use in Motor Vehicles Standard was implemented in Dec 09, the market response was fairly good. The M15 standard is different from M85 in that it does not require any modification to car engines. Therefore, it is widely expected that once the M15 standard is released nationwide, its market application will be much faster and prompt prices to go up. With an annual production capacity of 1.6m tonnes of methanol, China BlueChem will be a major beneficiary of the release of the standard. Major capacity expansion plans. China BlueChem has announced its plans to more than double its overall production capacity in the next five years, from 4m tonnes per year to 8.25m tonnes per year. It also plans to acquire Sino-Arab Compound Fertiliser Company, which has an annual production capacity of 1.2m tonnes of compound fertilisers. This potential deal will help China BlueChem to enter the compound fertiliser industry and achieve more integrated product catalogues.


High utilisation rate and strong distribution network. In 2010, the industry average utilisation rate of nitrogen fertiliser producers was only 77%, whereas the company’s utilisation rate was as high as 96.9%. This is mainly because of China BlueChem’s good sales and strong competitiveness over its peers. Besides, the company has a strong distribution network across China. Its close cooperation with the provincial distributors has enabled the company to maintain its sale-to-production at a leading level among all the fertiliser producers in China. For domestic distribution, the company mainly cooperates with China National Agricultural Means of Production Group Corporation; while for overseas sales, it mainly relies on Transammonia, an international fertiliser trading giant. Riding on favourable government policies. In the 12th Five-Year Plan, China aims to further consolidate the fertiliser industry and introduce more favourable policies for companies to adopt advanced and clean production technologies. It is estimated that the government’s consolidation measures will ease the current oversupply situation and the disorderly competition situation and wipe out small-scale and less efficient competitors. Large companies such as China BlueChem will definitely benefit from it.


Valuation With the strong support from its parent company CNOOC and up to 15 years of experience in the fertiliser industry, China BlueChem has been able to maintain a rather important position in the field. China’s determination to consolidate the fertiliser industry and increase the industry concentration is expected to promote orderly competition and benefit large-scale companies like China BlueChem. We have made key assumptions for the major product lines of the company in the valuation model to forecast future earnings. SALES VOLUME Urea The sales volume of urea for 2011 and 2012 will remain flat because the current utilisation rate is already slightly over 100% and the extra production increase is very limited. It is estimated that the major sales increase will come in 2013, when the newly-built coal-based fertiliser production bases come on stream. The preliminary sales volume forecast for 2013 is 2.7 m tonnes, taking into account the extra sales contributed by the new urea production bases. Downstream demand is expected to see a mild increase during the 12th Five-Year Plan based on China’s continued economic growth and the huge population’s need to upgrade their diet structure. Methanol Given the new methanol production facilities with a capacity of 800,000 tonnes coming on stream at end-10, sales volume in 2011 is expected to increase to 1.56m tonnes, almost double 2010’s figure. Given China BlueChem’s cost advantage and high utilisation rate and China’s booming methanol demand, it is forecasted that the sales volume for 2012 and 2013 will also almost equal the designed production capacity of 1.60m tonnes. The track record of the company also proves its capabilities in marketing and distributing. MAP/DAP For 2011, sales volume of mono-ammonium phosphate (MAP)/diammonium phosphate (DAP) will be flat. The Hubei Dayukou Di-Ammonium Phosphate (Hubei DYK) DAP project with a capacity of 500,000 tonnes/year will come on stream at end-11, thus 2012 sales volume will be about 980,000 tonnes. A similar sales volume is expected in 2013. POM The late trial of line C has affected the POM production expansion to some extent. With only line A and B running in 2011, it is expected that the sales volume will only be about 26,000 tonnes. In 2012 and 2013, the full-capacity production would be 60,000 tonnes. AVERAGE SELLING PRICE Urea The price hike in most of 2011 will lift the average selling price (ASP). It is projected that for 2011, the ASP will be about Rmb2,100/tonne. For 2012 and 2013, we believe the industry consolidation and price increases of feedstock will eliminate a large number of small-scale urea producers, hence stabilising the ASP at around Rmb2,050/tonne.


Methanol According to the latest discussions with the company’s representatives, for 2011, the ASP is projected to be around Rmb2,100/tonne. It is estimated that for 2012 and 2013, the ASP will see a gradual increase of about 5% in response to the widely expected release of M15 standard. MAP/DAP There has been a major price increase ytd in 2011 and it is estimated that the ASP for 2011 will be about Rmb3,050/tonne. With the new production capacity coming on stream in many places such as Hubei and Guizhou, it is projected that the ASP will drop to Rmb2,750/tonne and Rmb2,700/tonne in 2012 and 2013 respectively. POM The current price level is about Rmb12,000/tonne. We estimate the ASP for 2011-13 to be around this level because of stable supply and demand in the market. GROSS MARGIN Urea The gross margin (GPM) for 2011, 2012 and 2013 is projected to be 38%, 36% and 35% respectively. This is based on the historical average level and the consideration of extra competition from other large-scale urea producers. Methanol The price hikes in 2011 will lift GPM to about 39%. This level is expected to be maintained in 2012 and 2013 because of increased demand and the cost increase in electricity and labour. MAP/DAP GPM for 2011, 2012 and 2013 is projected to be 20%, 19% and 19% respectively. This is based on market situation of increased supplies in 2012 and 2013. POM The current GPM of China BlueChem’s POM business is 65%. It is estimated that the level can be sustained considering the high entry barriers.


Figure 2: Key Assumptions 2010 2011F 2012F 2013F

Sales volume ('000tonnes) Urea 1,984 1,950 1,950 2,700 Methanol 867 1,560 1,590 1,600 Compound fertiliser 31 50 50 50 POM - 26 60 60 MAP/DAP 480 480 980 980 Total 3,362 4,066 4,630 5,390 ASP (Rmb/tonne) Urea 1,772 2,100 2,050 2,050 Methanol 1,951 2,100 2,150 2,250 POM - 12,000 12,000 12,000 MAP/DAP 2,573 3,050 2,750 2,700 Turnover (Rmbm) Urea 3,515 4,095 3,998 5,535 Methanol 1,691 3,276 3,419 3,600 POM 0 312 720 720 MAP/DAP 1,234 1,464 2,695 2,646 Others 427 498 486 673 Total 6,867 9,645 11,317 13,174 Turnover breakdown (%) Urea 51 42 35 42 Methanol 25 34 30 27 POM 0 3 6 5 MAP/DAP 18 15 24 20 Others 6 5 4 5 Total 100 100 100 100 Gross margin/ Assumptions (%) Urea 37 38 36 35 Methanol 35 39 39 39 POM 0 65 65 65 MAP/DAP 19 20 19 19 Others 13 13 13 13 Overall 32 35 34 33

Source: China BlueChem, UOB Kay Hian We initiate coverage with a BUY recommendation and set a target price of HK$7.30 based on 13x 2012F PE. Figure 2 shows several of China BlueChem’s peers in the fertiliser industry and we believe the target price is reasonable considering China BlueChem’s leading position in the industry and its expansion plans.


Figure 3: Peer Comparison

Market P/B P/E P/E P/E ROE GPM EV/

EBITDA Ticker Company Name Cap Price 2010 2010 2011F 2012F 2010 2010 2011 (Lcy billion) (Lcy) (x) (x) (x) (x) (%) (%) (x)

Average Average 22.9 256.2 2.1 21.8 15.6 12.7 15.17 23.10 10.6

297 HK Sinofert Holdings 14.6 2.2 1.0 28.2 11.3 10.4 4.33 5.09 10.3

3983 HK China Bluechemical 26.8 5.9 2.1 19.0 11.1 10.5 11.61 31.87 5.9

1866 HK China XLX 2.0 2.0 1.0 10.0 9.1 7.5 9.44 12.77 6.1

000422 CH Hubei Yihua 9.1 16.6 2.5 10.2 11.4 9.2 23.39 22.39 9.2

600426 CH Shandong Hualu Hengsheng 8.2 8.7 1.6 20.4 17.9 10.9 6.74 13.14 9.9

000830 CH Luxi Chemical 8.2 5.7 1.6 17.8 18.7 13.3 8.55 10.39 8.4

600096 CH Yunnan Yuntianhua 11.1 16.8 1.7 62.9 42.5 27.0 4.00 22.53 12.2

600230 CH Liuzhou Chemical 2.0 7.9 1.6 48.9 24.6 23.8 8.20 17.86 16.0

600470 CH Liuguo Chemical 4.1 8.1 1.8 32.4 26.8 22.6 4.95 8.30 12.0

000792 CH Qinghai Salt Lake 54.9 37.2 4.0 21.5 15.7 12.4 32.19 54.66 12.4

AGU US Agrium Inc 10.2 64.5 1.6 7.6 6.9 6.8 14.37 23.97 4.8

POT US Potash Corp Of Saskatchewan 33.2 38.8 4.5 11.6 10.6 9.0 27.28 40.15 7.6

SDF GR K+S Ag-Reg 6.5 33.7 2.3 10.0 9.6 8.7 18.92 38.41 5.4

YAR NO Yara International Asa 64.5 221.0 1.6 6.3 6.4 7.0 27.33 11.67 4.3

ICL IT Israel Chemicals 45.2 3,560.0 3.9 8.5 7.6 7.1 38.00 42.73 5.9

1722 TT Taiwan Fertilizer 66.3 69.5 1.3 33.4 19.5 17.1 3.45 13.74 39.7

Source: Bloomberg, UOB Kay Hian


Financials China BlueChem started as a mid-sized urea plant in Dongfang City in 1996. Since then, it has been developing very rapidly in the past 15 years. Revenue growth accelerated from Rmb3.5b in 2006 to Rmb6.9b in 2010, indicating a CAGR of up to 18.6%. The company will continue to see more growth with its additional methanol, DAP, POM and urea production coming on stream in the next three years. Based on the announced expansion plans, both revenue and profits will see a major jump in the next three years. Especially for 2011, with 800,000-tonnes in methanol production coming on stream, revenue is projected to hit Rmb9.6b, implying a 40% yoy increase. It is estimated that the revenue CAGR from 2010 to 2013 is about 18%, and the EPS CAGR from 2010 to 2013 is about 19% thanks to the expansion plans. The company has been able to maintain GPM at over 30% in the past few years, which is impressive considering fierce competition and severe oversupply in China’s fertiliser industry. Due to the long-term natural gas supply contract with CNOOC and its good ties with distributors, it is expected that the company will be able to maintain the high GPM without having to worry about the feedstock cost increases. Due to the company’s high GPM and good distribution system, China BlueChem has a very healthy cash flow, with an interest cover multiple of more than 300. It is believed that this reflects the company’s operating efficiency and will help to hedge against potential interest hikes in the market. EARNINGS OUTLOOK Solid earnings growth can be expected. China BlueChem’s earnings growth will come from the following four factors: a) Expansion plans to contribute extra production capacities. The company

finished the 8m tonnes/year methanol project in late-10. Apart from this, China BlueChem is busy with the DYK 500,000 tonnes/year DAP project. It is also in talks with enterprises and local governments on coal mine acquisitions, which are expected to contribute 1m tonnes/year to urea production capacity in 2013. The expansion plans will help boost economies of scale and reduce unit costs.

b) Government-led consolidation to wipe out small-scale urea producers to promote orderly competition. Currently, there are many small urea producers scattered across China. These urea producers consume a lot more energy than the industry average level and cause serious problems. Besides, they tend to sell urea with quality issues to make profits, which disturbs the normal market competitive order. The 12th Five-Year Plan aims to eliminate these producers and issue favourable policies for large-scale urea producers such as China BlueChem.

c) Continued efforts in gaining coal resources. With the government’s natural gas pricing reforms and moves to discourage the building of new gas-based fertiliser facilities, the company has begun to seek coal resources for its urea expansion plans. The acquired coal resources will help the company to secure feedstock supplies and reduce unit costs. It is believed that these moves by management reflect their strong dedication to long-term development and far-sighted market strategies.

d) Entry into fine chemical engineering with high value-added products. The company has been striving hard in the research and development of fine chemical engineering. It already owns POM production facilities and aims to develop further into the field of deep catalytic cracking (DCC) and methyl tert-butyl ether (MTBE).


Industry Outlook

FERTILISERS Fertiliser is defined as organic or inorganic material of natural or synthetic origin, which is used in soil to supply one or more plant nutrients essential to plants’ growth. International studies show that about 40-60% of crop yields are attributable to the application of fertilisers. Organic fertilisers are naturally occurring fertilisers, including manure, slurry, worm castings, peat, seaweed, humic acid and guano. Due to the limited scale of such fertilisers and the higher transportation costs, organic fertilisers are usually locally consumed in the neighbouring arable areas and not intended for commercial purposes. Mined inorganic fertilisers have been used for many centuries, while chemically synthesised inorganic fertilisers were only widely developed during the industrial revolution. Inorganic fertiliser use has significantly supported global population growth. It has been estimated that almost half of the world’s population are currently fed as a result of fertiliser use. Fertiliser also enables upgrading the diet structure in many developing countries. Fertiliser usually provides some macronutrients and micronutrients essential for plants’ growth. The macronutrients include: nitrogen (N), phosphorus (P), potassium (K), calcium (Ca), magnesium (Mg) and sulfur (S); while the micronutrients include boron (B), chlorine (Cl), copper (Cu), iron (Fe), manganese (Mn), molybdenum (Mo) and zinc (Zn). Generally, the biggest commercial demand for the macronutrients comes from nitrogen, phosphorus and potassium. There are many kinds of nitrogen, phosphorus and potassium fertilisers available in the market. And also this range of fertilisers can be further blended and treated to produce compound fertilisers. Many soils require the addition of several essential nutrients to alleviate plant deficiencies. Farmers may have the option of selecting a combination of single-nutrient fertilisers or using a fertiliser that has several nutrients combined into each particle. These combination (compound or complex) fertilisers can offer advantages of convenience in the field, economic savings, and ease in meeting crop nutritional needs. Figure 4: Fertiliser Consumption In China

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Bargaining power over suppliers. Fertiliser producers buy coal and petroleum-related materials from suppliers. For nitrogen fertilisers, the raw materials for synthetic ammonia - the major intermediate product - come from natural gas and coal. Currently, the price increase of natural gas and coal has significantly increased the cost pressure for nitrogen fertiliser producers. Accounting for only a small proportion of downstream clients, fertiliser producers are in a weak position in terms of bargaining power. This is why the price fluctuations of natural gas and coal usually have a material impact on the fertiliser producers’ gross margins. For phosphorus fertiliser producers, the major cost comes from the procurement of sulphur and phosphate ore. According to China Sulphuric Acid Industry Association, 90% of the sulphur consumed in China has to be imported. And the sulphur used in the production of phosphorus-based and related compound fertilisers accounts for 60% of the total imported amount. Thus, Chinese phosphorus fertiliser producers have almost no control over the prices of imported sulphur. As for phosphate ore, although China has a large amount of phosphate ore reserve (mainly in Yunnan, Hubei, Sichuan and Guizhou), the low ore grade and the underdeveloped mining technology have been keeping cost at a relatively high level. In the case of potassium fertilisers, China’s huge demand far exceeds domestic supply. China’s potassium resources are largely stored in the Qinghai Salt Lake, and can only satisfy about 50% of overall demand. Globally, Canadian Potash Exporters (Canpotex), including Potash Corp, Mosaic and Agrium; and Belarusian Potash Company (BPC), including Belaruskali and Uralkal, account for about 80% of the world’s potassium fertiliser production capacity. The duopoly means that China, along with other major importing countries such as India and Brazil, have to accept high import prices. Because global potassium resources are mostly owned by Canada, Russia, Germany and the Middle East, these countries and regions have been striving to consolidate potassium resources and have formed several big groups to consolidate their control over the global supply of potassium fertilisers. Importing countries like China have to sign contracts with the global giants on a yearly basis. Due to the domestic supply constraint, it is widely expected by the fertiliser industry that China will have to import about 50% of the potassium fertilisers it needs for the next few years. Chinese importers have weak bargaining power with overseas potassium fertiliser producers. Bargaining power over customers. Customers include farmers engaged in agricultural production. As the customer base is highly fragmented, farmers have extremely weak bargaining power. Unlike several years ago, the government now has done away with price control. Instead, the government provides subsidies to the farmers, encouraging the application of fertilisers. Currently, the price is totally determined by market demand and supply. As for export sales, prices are determined by market demand and supply as well. Threats from new entrants. One significant characteristic of the fertiliser industry is economies of scale. The initial capital investment is huge. New entrants are also supposed to own very strong technological background to compete with existing peers. Despite the severe oversupply situation in the nitrogen and phosphate fertiliser industry in China, we still see some players entering as a result of the local governments’ requirements about the coal’s on-site conversion rate. To promote the local economy, some governments in the coal-intensive areas demand that the coal’s on-site conversion rate must not be lower than a pre-set level. Given that the construction cycle of fertiliser project is relatively shorter, some coal and power


companies choose the coal-to-fertiliser programme to meet the governments’ requirements so as to get the coal resources they need. Projects like these usually are very big in terms of scale and adopt advanced coal gasification technologies. Besides, as these fertiliser companies are located in the resources area, they actually accord with the national industrial policies. According to China Petroleum and Chemical Industry Federation (CPCIF), the 12th Five-Year Plan will aim to gradually shut down and wipe out small-scale fertiliser companies with underdeveloped technologies and emit heavy pollutions. Currently, there are more than 470 nitrogen fertiliser producers and 360 phosphate fertiliser producers. The government plans to reduce the figures respectively to 200 and 150. In the meantime, the government will issue some favourable policies for large-scale fertiliser producers with advanced technologies. This trend is widely expected as the nation plans to consolidate the fertiliser industry, promote orderly competition and upgrade the development of the whole industry. It is believed that the 12th Five-Year Plan will be a positive catalyst to existing industry plays such as Sinofert and China BlueChem. Threats from substitute products. Commercial fertilisers are required for agricultural production. The only substitute comes from organic fertilisers (ie organic manure from the animal husbandry and poultry farming). Due to limited supply, organic fertilisers are hardly intended for commercial purposes; these substitutes are only locally consumed. Therefore, there is no material threat from them. Figure 5: China’s Fertiliser Imports

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Source: China Petroleum and Chemical Industry Association Figure 6: China’s Fertiliser Exports

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NITROGEN FERTILISER INDUSTRY OVERVIEW Figure 7: Major Types Of Nitrogen Fertilisers

Nitrogen Fertilisers a) Essential for plant growth, b) important component of proteins and chlorophyll, and c) most responsible for yield increases.

Ammonia (NH3) Used as a fertiliser and as a building block for other nitrogen products. Ammonia consists of about 82% nitrogen. Usually stored in liquid form under pressure or refrigerated and can be directly applied to plants.

Urea ((NH2)2CO) Formed by reacting ammonia with carbon dioxide (CO2) at high pressure. It contains about 46% nitrogen and the finished product is usually in solid form. It can be applied to soil or combined with ammonium nitrate.

Ammonium nitrate (AN) (NH4NO3)

Produced from ammonia by reacting with nitric acid. Ammonium nitrate is a solid fertiliser containing about 34% nitrogen. It is water soluble and used in various fertiliser solutions.

Ammonium sulphate (AS) Has a relatively low nitrogen content (only 21%). It contains about 24% sulphur. It is usually applied to soil which lacks sulphur.

Source: Journal of Chemical Fertilizer Industry Nitrogen fertiliser producers dominate the industry in China, with 472 above-scale players as of end-10. Figure 8: Statistics Of China’s Nitrogen Fertiliser Producers

Year No. of

enterprises No. of employees Total asset

(Rmbb) Growth rate

(%) Total liabilities

(Rmbb) Growth rate

(%)

2006 551 435,128 211.92 22.4 127.174 19.3 2007 518 411,247 234.31 15.2 143.452 17.6 2008 505 406,915 289.26 23.4 182.835 24.4 2009 485 396,126 317.43 9.3 208.225 16.2 2010 472 378,524 352.21 10.5 239.548 14.7

Source: National Bureau of Statistics Production. Nitrogen fertiliser production volume in 2010 saw a slight dip from 2009, mainly because of weak ASP, energy saving and emission reduction policies, power shortage and increase of raw material costs. Figure 9: Production Volume Of Nitrogen Fertilisers

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Figure 10: Gross Output Value Of The Nitrogen Fertiliser Industry

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Source: National Bureau of Statistics Although the production volume declined in 2010, the industry’s gross output value saw an 18.53% increase. This was mainly attributable to the fact that the overall ASP in 2010 recorded a notable increase. Figure 11: Domestic Sales Value Of Nitrogen Fertilisers

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Figure 12: Sales-output Ratio Of The Nitrogen Fertiliser Industry

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Development trend. Nitrogen fertilisers are made from coal, petroleum and natural gas. China’s energy sources reserve is characterised by oil shortage, gas insufficiency and coal abundance. Companies using petroleum to make nitrogen fertilisers have lost competitive advantage and have been wiped out of the market in recent years. Currently, 30% of nitrogen fertilisers are made from natural gas and the remaining 70% relies on coal. As the most basic fertiliser product, nitrogen fertiliser is in excess supply for many years. The severe oversupply has kept prices at a relatively low level that actually puts a lot of domestic plays on the verge of making loss. On the other hand, in an effort to stabilise domestic prices and to secure fertiliser supply for plantation, China has been levying high export tariffs on a variety of fertiliser products, which has made it very hard for some producers to make profit via exports. With coal and natural gas prices soaring, some small nitrogen fertiliser producers that are remote from coal resources or natural gas bases and lack pollution control facilities will be pressured by both market competition and the government’s unfavourable policies to ultimately shut down. It is widely expected that fertiliser producers with sound management, advanced equipment, locally available raw materials and energy saving and emission reduction measures will be the mainstream players in future. PHOSPHATE FERTILISER INDUSTRY OVERVIEW Figure 13: Major Types Of Phosphate Fertilisers

Phosphate fertilisers Phosphorus is the main nutrient for phosphate fertilisers. Phosphorus occurs in natural geological deposits known as phosphorus rock. To make the rock soluble and available to plants, Phosphate rock is reacted with sulphuric acid to produce phosphoric acid. It is responsible for all processes in plant life, in which energy is stored and utilised, and it encourages rooting, blooming and fruit production in plants.

Single superphosphate (SSP) Produced by treating phosphorus rocks with phosphoric acid. SSP contains around 16-20% phosphate.

Triple superphosphate (TSP) Produced by treating phosphorus rocks with phosphoric acid. TSP is a highly concentrated form of phosphate fertiliser with almost 46% phosphate. Usually in granular and non-granular form.

Source: Journal of Chemical Fertilizer Industry The size of the phosphate fertiliser industry is smaller than that of nitrogen and compound fertilisers, but larger than that of potash fertilisers. As end-10, there were 366 above-scale phosphate fertiliser producers in China. Figure 14: Statistics Of China’s Phosphate Fertiliser Producers

Year No. of


(Rmbb) Growth rate


(Rmbb) Growth rate

(%)

2006 395 104,839 42.23 20.9 26.43 23.2 2007 400 93,105 44.39 18.3 28.25 19.1 2008 392 88,334 60.46 22.2 38.19 29.3 2009 371 78,809 45.28 0.6 29.30 0.8 2010 366 78,542 55.64 24.0 35.82 24.8



Figure 15: Production Volume Of Phosphate Fertilisers

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10

12

14

16

18

2006 2007 2008 2009 2010

(m tonnes)

Source: National Bureau of Statistics Figure 16: Gross Output Value Of The Phosphate Fertiliser Industry

0

10

20

30

40

50

60

2006 2007 2008 2009 2010

(Rmb b)

Source: National Bureau of Statistics Figure 17: Domestic Sales Value Of Phosphate Fertilisers

0

10

20

30

40

50

60

2006 2007 2008 2009 2010

(Rmb b)



Figure 18: Sales-output Ratio Of The Phosphate Fertiliser Industry

109.49107.23

99.3100.52 101.04

94

96

98

100

102

104

106

108

110

112

2006 2007 2008 2009 2010

(%)

Source: National Bureau of Statistics Development trend. China’s total phosphate fertiliser production hit 17m tonnes in 2010, whereas domestic demand was only 12m tonnes. Similar to nitrogen fertilisers, the government also levies export tariffs on exported fertilisers. It is widely expected that the prices will remain relatively low. Companies with phosphate ores have an edge over peers. COMPOUND FERTILISER INDUSTRY OVERVIEW Figure 19: Major Types Of Compound Fertilisers

Compound Fertilisers Description

1) Complex fertilisers Result from chemical reactions between chemical raw materials and intermediates. Complex fertilisers are the most effective way to achieve balanced nutrition since they contain an engineered amount of primary nutrients in each granule, permit even application of nutrient.

Mono-ammonium phosphate (MAP)

Contains 52% phosphate; usually in granular form; can be used either directly or for blending with other types of fertilisers.

Diammonium phosphate (DAP)

Contains 46% phosphate; usually in granular form; can be used either directly or for blending with other types of fertilisers.

2) Blended fertilisers Obtained by drying and mixing of several materials without the involvement of chemical actions.

BB fertilisers Bulk blended from the mixture of N, P and K fertilisers.

Source: Journal of Chemical Fertilizer Industry The compound fertiliser industry is only second to the nitrogen fertiliser industry in terms of scale. Figure 20: Statistics of China’s Compound Fertiliser Producers

Year No. of


(Rmbb) Growth rate


(Rmbb) Growth rate

(%)

2006 848 155,055 85.82 19.9 52.88 27.7 2007 935 168,927 103.48 17.5 62.67 14.2 2008 1,012 170,222 116.96 23.9 72.61 21.2 2009 1,182 176,267 120.22 11.9 71.07 4.2 2010 1,307 194,133 153.16 24.2 86.98 18.3



Figure 21: Gross Output Value Of Compound Fertiliser Industry

0

50

100

150

200

250

2006 2007 2008 2009 2010

(Rmb b)

Source: National Bureau of Statistics Figure 22: Domestic Sales Value Of Compound Fertilisers

0

50

100

150

200

250

2006 2007 2008 2009 2010

(Rmb b)

Source: National Bureau of Statistics Figure 23: Sales-output Ratio Of The Compound Fertiliser Industry

95.9

98.0

97.1

96.6

94.9

93

94

95

96

97

98

99

2006 2007 2008 2009 2010

(%)

Source: National Bureau of Statistics Development trend. China’s compound fertiliser industry started late but expanded very quickly in the recent years. Currently, China still lacks the capabilities to develop high-end compound fertilisers. It is worth noting that although China’s total compound fertiliser production capacity is already sufficient for the domestic market, China still imports a large amount of compound fertilisers because of their proven reliability and efficiency.


Thus, fertiliser producers need to enhance production technologies and promote fertiliser efficiencies to progress. As water resources are becoming more and more precious, China is now promoting the water saving project, which brings great opportunities for the development of high-end soluble fertilisers such as nitro compound fertiliser, ammonium polyphosphate, and ammonium thiosulfate. Besides, as the special compound fertiliser tailored for cash crops help to promote growth and harvest by a much larger extent, more varieties of such compound fertilisers can be developed to boost profits. POTASH FERTILISER INDUSTRY OVERVIEW Figure 24: Major Types Of Potash Fertilisers

Potassium fertilisers Potassium is involved in the production, transportation and accumulation of sugars in the plant. It maintains electrical balance within the plant cell and assists the hardiness of plants and their resistance to water stress, pests and diseases.

Potassium Chloride (KCI)/muriate of potash or MOP

Contains 40-60% of potash

Potassium sulphate (SOP) (K2SO4) Contains 50% potash, usually used for plants that are particularly sensitive to chlorine, such as potatoes, fruits, vegetables and tobacco.

Source: Journal of Chemical Fertilizer Industry The dynamics of China’s potash fertiliser industry is quite different from those of nitrogen and phosphate fertiliser industries. China’s potash resources only account for 1.8% of the world’s total reserve, while China consumes more than 20% of the world’s total consumption. Because of the lack of the resources, China has to import a huge proportion of the potash fertiliser it needs. 90% of the world’s potash fertiliser resources are controlled by a few fertiliser giants such as Potash Corp, which form leagues to collectively control the capacity utilisation rate and hence prices. Therefore, prices of potash fertilisers are almost entirely determined by them. Countries such as China, Brazil and India do not have much bargaining power. Besides, many potash fertiliser producers are considering acquiring other producers to consolidate their bargaining power. Figure 25: World Demand For Potash Fertilisers

Brazil13%

Western Europe10%

Other Asian Countries

13%

Other Areas19%

India8%

China20%

United States17%

Source: IFA


With the increased effort to discover and tap domestic potash resources, China has been able to gradually reduce the proportion of imported potash to 50% currently. However, as China’s domestic reserve is very limited and cannot entirely offer a sustainable support for fertiliser demand from its large-scale agriculture, it is widely expected by the industry that China will have to keep importing about 50% of its potash fertiliser requirement for several years. The general Nitrogen: Phosphorus: Potassium ratio in the world is about 1: 0.4: 0.4, which is suitable for the purpose of maintaining soil fertility. However, when it comes to China, the ratio becomes 1: 0.4: 0.16, which has caused a severe lack of potassium in most of China’s arable soil. The most important reason is that the farmers can’t afford the high prices of potash fertilisers or simply believe that applying the expensive potash fertilisers does not make economic sense. Potassium is one of the three most important elements for crops’ growth. It is involved in the activation of photosynthesis, assimilate transportation, carbohydrate metabolism and protein synthesis process. Under-application of potash fertilisers has caused a very serious constraint for China’s agricultural production and triggered an alarm for the nation’s food security. According to industry experts, China’s long-term plan is to satisfy one-third of its needs for potash fertiliser by domestic production, one-third by imports and one-third by overseas direct investment in potash resources development projects. Figure 26: China’s Potash Fertiliser Production

20 24 37 167 303 395 386607

1,2421,500

2,0902,496

2,775

3,6283,968

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

1980 1985 1990 1995 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

('000 tonnes in K2O)

Source: National Bureau of Statistics Figure 27: China’s Potash Fertiliser Consumption

0.30.8

1.5

2.7

3.8 4.0 4.2 4.4 4.7 4.9 5.1 5.3 5.5 5.6 5.9

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

1980 1985 1990 1995 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

(m tonnes in K2O)

Source: CEIC


According to the 2H11 results of the fertiliser import negotiations, the cost, insurance and freight (CIF) is US$470/tonne, which is US$70 higher than 1H11, up 17.5% hoh. This is higher than the previous market expectation of US$450/tonne, resulting in a lot of challenges. The highest import price was in 2008 when the price hit US$650/tonne. Currently, there are in total 10 companies that have the licences to import potash fertilisers, including Sinofert, Sino-Agri, China BlueChem, Sino-Arab Chemical Fertilizers (SACF), CNCCC, Huaken International Trade Company, Shandong Lubei Company, Shandong Luxi Chemical Company, Xiyang Group and Hubei Yangfeng Company. It has been a practice that the eight companies besides Sinofert and Sino-Agri can elect one representative to attend the negotiations together with them. As a matter of fact, the industry has been following a ‘two-eight division” principle. According to the principle, only Sinofert and Sino-Agri can sign contracts with the potash fertiliser exporters, while the other eight companies can only sign supply contracts with the overseas subsidiaries of Sinofert and Sino-Agri, which essentially means that Sinofert and Sino-Agri still controls 100% of the potash fertiliser supply towards China. METHANOL Methanol is a widely used chemical feedstock. Methanol is a transparent liquid chemical used as a raw material for the production of more than 100 chemical products, which are widely used in the production of adhesive agents, synthetic fibre, synthetic rubber, solvents and dyestuffs. The main product made from methanol is formaldehyde, representing 27% of global methanol demand. 80% of formaldehyde is used as adhesive agent for building industries. The production of MTBE represents around 8% of global methanol demand. MTBE is used primarily as a source of octane, an additive to gasoline to improve its anti-knock performance and combustion efficiency. Figure 28: Demand For Methanol From Different Downstream Products

Downstream Products Lines (%) 2007 2008 2009 2010

Formaldehyde 37 36 32 27 DME 12 15 22 19 Fuel Blending 16 15 13 12 Acetic acid 8 10 10 11 MTBE 4 6 6 8 Methylamine 7 4 3 3 Others 17 14 14 20 Total 100 100 100 100

Source: China Petroleum and Chemistry Association Methanol as alternative energy. Given the surge in oil prices, methanol is increasingly used as an alternative energy source to substitute for petroleum fuel, such as fuel blending and dimethyl ether (DME). Methanol shares many characteristics of gasoline, and thus can be blended with gasoline to serve as fuel for vehicles. Many regular engines could be easily adopted to use this blended liquid fuel. M15 consists of 15% methanol and 85% unleaded gasoline. As M15 is a low blend, no modification of engines is required. With technological advancement, higher concentration of methanol can be blended with gasoline to fuel vehicles. Currently, M85 (85% methanol and 15% of unleaded gasoline) has become the major standard for methanol fuel in developed countries, eg the US.


Methanol can also be used to produce DME (1.5 tonne methanol is required to produce 1 tonne DME), a clean burning alternative fuel that serves as substitute for liquefied petroleum gas (LPG), diesel and gasoline. The major market opportunities for DME are its use as an LPG alternative, in power generation and household heating and as a substitute for diesel and gasoline as a transportation fuel. DME can be blended up to 25% with gasoline and diesel to form vehicle fuel. With minor modification, conventional engines can use DME as fuel. Many countries are developing DME projects, including China and those in the Middle East. China is emerging as a large consumer of methanol. To reduce its reliance on imported oil and pollution, China is actively promoting the use of methanol as a substitute for petroleum fuel, including methanol fuel and DME. It is because the country’s rich coal reserve guarantees enough raw material sources for the development of the methanol industry. In Nov 06, the State Council of China officially ensured the country’s commitment to develop the applications of methanol as an alternative energy to petroleum fuel with an estimated investment of over Rmb1t in 2006-20. In contrast, to preserve food security, methanol projects using corn as feedstock have been cracked down. Shanxi province has formally proposed to require all gasoline stations in the province to sell M15 methanol fuel, which can be used by normal vehicles without modification. Assuming methanol is blended with gasoline under M15 standard, the additional demand for methanol in Shanxi would be around 250,000 tonnes a year. If all gasoline sold in China is blended with methanol under M15 standard, an additional 18.8m tonnes of methanol demand would be generated. The DME market in China is expected to see strong growth. The state targets to increase total annual capacity for DME to 12m tonnes in 2015 and 20m tonnes in 2020, translating into 18m tonnes and 30m tonnes of additional methanol demand during the periods. China’s methanol industry started in the 1950s and experienced a strong growth after 2002 when the downstream demand was booming. In 2010, China’s total production capacity was 37.6m tonnes, becoming the biggest methanol-producing country in the world. China’s domestic methanol apparent consumption was only 4.3m tonnes in 2003 and 20.9m tonnes in 2010, which implies a CAGR of more than 25%. China’s self-sufficiency ratio increased from 2003’s 68.9% to 2007’s 97.3%. But due to the financial crisis impact in 2009 and the cost advantages of the foreign competitors using natural gas, China’s imports increased significantly, dragging the ratio down to 68.0%. In 2010, the ratio increased to 75.3%. Figure 29: China's Methanol Production and Consumption

Year Output Imports Exports Apparent

Consumption Output/Apparent

Consumption Imports/Apparent

Consumption Dependence on imports

(‘000 tonnes) (‘000 tonnes) (‘000 tonnes) (‘000 tonnes) (%) (%) (%)

2003 2,988.7 1,401.6 50.8 4,339.5 68.87 32.30 31.13

2004 4,406.0 1,359.0 33.0 5,732.0 76.87 23.71 23.13

2005 5,356.4 1,360.3 54.5 6,662.2 80.40 20.42 19.60

2006 7,458.0 1,127.0 190.0 8,395.0 88.84 13.42 11.16

2007 10,126.0 845.0 563.0 10,408.0 97.29 8.12 2.71

2008 11,099.0 1,434.0 368.0 12,165.0 91.24 11.79 8.76

2009 11,230.0 5,288.0 13.8 16,504.2 68.04 32.04 31.96

2010 15,753.0 5,189.0 12.4 20,929.6 75.27 24.79 24.73

Source: Top Fortune Commodities


Figure 30: Consumption

North China15.5%

South China11.6%

Central China11.0%

Northwest4.3%

Other13.1%

East China44.4%

Source: China Petroleum and Chemistry Association Figure 31: China's Methanol Imports and Exports

Year Imports Exports Dependence on imports (‘000 tonnes) (‘000 tonnes) (%)

2001 1,521 9.6 42.26 2002 1,799 0.9 46.02 2003 1,402 50.8 31.13 2004 1,359 33 23.13 2005 1,360 54 19.60 2006 1,127 190 11.16 2007 845 563 2.71 2008 1,434 367.6 8.76 2009 5,288 13.8 31.96 2010 5,189 12.4 24.73

Source: China Customs Figure 32: Top Five Exporters Into China (2010)

Country Volume Percentage (‘000 tonnes) (%)

Iran 2,153.4 41.50 Saudi Arabia 739.4 14.25 Oman 679.2 13.09 Qatar 438.0 8.44 Malaysia 203.9 3.93

Source: China Customs Figure 33: China's Methanol Capacity and Output

Year Capacity Capacity growth Output Production growth (‘000 tonnes) (%) (‘000 tonnes) (%)

2004 7,320 22.00 4,410 47.42 2005 8,930 21.99 5,360 21.57 2006 13,990 56.66 7,460 39.24 2007 20,320 45.25 10,130 35.77 2008 23,380 15.06 11,100 9.61 2009 27,170 16.21 11,230 1.17 2010 37,570 38.26 15,750 40.28

Source: Top Fortune Commodities


Figure 34: Energy Source Breakdown For Methanol Production (2010)

Coal63.0%

Natural gas21.2%

Coke oven gas15.8%

Source: Methanol Institute Development trend in China. The major development trend for the methanol industry is to move to the energy-intensive bases. Regions like Inner Mongolia, Henan, Shanxi, Shaanxi, Chongqing are ideal places for methanol production because of their advantages in energy resources. Historically, Shandong has been the biggest player in China’s methanol industry. However, the expanding rate in Shandong is expected to slow down because of resource constraints. In 2010, the top ten producers took up about 29.0% of total capacity. Figure 35: Top 10 Producers (2010)

Name Capacity (‘000 tonnes/year)

Shenhua Baotou Coal Chemical 1,800 China BlueChen Jiantao 1,400 Inner Mongolia Yuanxing Energy 1,330 Shandong Jiutai Chemical 1,250 Yanzhou Coal 1,130 Xinao Group 960 Ningxia Shenhua Coal 850 Shanghai Coking & Chemical 800 Henan Pingmei & Lantian 730 Huadian Yulin Natural Gas Chemical 630 Total 10,880

Source: China Nitrogen Fertiliser Industry Association Figure 36: Global Supply-demand Dynamics

Year Capacity

(m tonnes) Output

(m tonnes) Demand

(m tonnes) Utilisation rate

(%)

1999 34.98 28.01 27.37 80.10 2000 38.03 29.09 28.17 76.50 2001 38.41 29.57 28.99 77.00 2002 38.41 30.65 29.84 79.80 2003 40.13 31.40 30.71 78.25 2004 40.60 33.00 31.80 81.30 2005 43.35 35.77 35.76 82.50 2006 46.06 36.27 36.29 78.70 2007 52.09 39.03 38.97 74.90 2008 59.12 40.28 40.45 68.10 2009 75.00 42.11 42.07 56.15 2010 98.45 57.00 45.20 57.90

Source: MMSA Global


Global methanol production. Globally, the world’s methanol production base is mainly located in natural gas-intensive areas. These areas include the Middle East (Saudi Arabia, Iran, etc), Caribbean and Latin America (Venezuela, Chile, etc), Southeast Asia (Indonesia, Malaysia, etc), the former Soviet Union and China. It is estimated that in 2015, the global methanol production capacity will be about 100m tonnes and the actual output will be about 75m-80m tonnes. Globally, there are seven methanol giants accounting for about 44% of the world’s total production capacity. The biggest methanol producer is Methanex headquartered in Canada with an annual production capacity of over 8m tonnes. Methanex is responsible for about 21% of the world’s total production capacity. The second biggest one is Saudi Basic Industries Corporation (SABIC) with 9% of the world’s total production capacity. Apart from the two, Borden and BMC in the US, TOMCK and Gubaha in Russia and Edmonton in Canada also rank among the best producers. Areas such as the Middle East, Latin America and North Africa appeal to a lot of investors because of their sufficient and cheap natural gas resources. In the next few years, there will be many methanol projects under construction in the Middle East. Figure 37: Global Methanol Production By Top Producers (2010)

Producer Country/Region Capacity (m tonnes)

Methanex Chile 3.84 Methanex Trinidad 2.55 Methanex New Zealand 2.40 Methanex Egypt 0.00 (1.3 under construction) Sabic Saudi Arabia 4.80 Sabic Bahrain 0.45 NPC Iran 1.08 ZPC Iran 3.00 KPC Iran 0.66 Omen Methanol Oman 1.00 Salalah Methanol Oman 1.00 Petronas Malaysia 2.36 Kaltim Indonesia 0.66 Medco Indonesia 0.33 QAFAC Qatar 1.00 BMC Brunei 0.85 Others 30.21

Source: World Methanol Industry Overview


Company Background

China BlueChem is one of the largest and most efficient nitrogen fertiliser producers in terms of production volume and energy consumption in China. Its core business is the production and sale of urea, the most commonly used nitrogen fertiliser in China. Besides, the company also produces phosphate fertilisers. As one of the major subsidiaries of CNOOC, the third largest petroleum company in China, and a sister company of CNOOC Limited, one of the world’s largest oil and gas exploration and production companies in terms of reserves, China BlueChem is well-positioned to further enhance its fertiliser operations through organic expansion. The company has also expanded into the production of high value-added synthetic chemical products such as methanol and POM. Figure 38: China BlueChem’s Production Facilities

Source: China BlueChem, UOB Kay Hian Most of its production facilities use natural gas as the principal raw material for their production of urea and methanol. Natural gas is considered to be more environmentally friendly compared with other natural resources, such as coal and oil, as combustion of natural gas releases fewer harmful pollutants into the atmosphere. The company’s production complex in Hainan is conveniently and strategically located in an area close to abundant sources of natural gas supplied from offshore gas fields operated by CNOOC. China BlueChem has entered into long-term natural gas sale and purchase agreements on a take-or-pay basis to provide its production complex in Hainan with stable and reliable supplies of natural gas. CNOOC, the dominant developer of offshore oil and gas resources in China, has the exclusive right under current Chinese regulations to enter into production sharing contracts with international oil and gas companies for crude oil and gas exploration and production offshore China. CNOOC has now expanded into midstream and downstream petroleum businesses. China BlueChem is one of the major downstream businesses of CNOOC, concentrating on natural gas-based fertilisers and chemicals. As the sole subsidiary of CNOOC engaged in the fertiliser business, China BlueChem possesses huge competitive advantages over its peers.


Figure 39: China BlueChem’s Production Lines

Product Project Location Ownership

(%) Production Capacity ('000 tonnes per year)

Fudao Hainan 100 520 Fudao Hainan 100 800 Tianye Inner Mongolia 90 520 Hualu Shanxi 51 Under Construction Hegang Heilongjiang 80 Under Construction

Urea

Subtotal 1840

CNOOC Jiantao Hainan 60 600 CNOOC Tianye Inner Mongolia 90 200 Hainan Hainan 100 Under Construction

Methanol

Subtotal 800

POM Tianye Inner Mongolia 100 Under Construction

DAP & MAP DYK Hubei 83 500

Source: China BlueChem Figure 40: Revenue Breakdown (2009) Figure 41: Revenue Breakdown (2010)

Mathanol21%

Phosphate17%

Others5%

Urea57%

Mathanol25%

Urea51%

Others6%

Phosphate18%

Source: China BlueChem Source: China BlueChem Figure 42: Gross Profit (2009) Figure 43: Gross Profit (2010)

Urea69%

Mathanol18%

Phosphate10%

Others3%

Urea58%

Mathanol28%

Others3%

Phosphate11%

Source: China BlueChem Source: China BlueChem Figure 44: Gross Margin Breakdown

Products (%) 2009 2010

Urea 36.5 38.0 Phosphate 17.7 19.3 Mathanol 25.1 34.3

Source: China BlueChem


Figure 45: Turnover

4,340

5,518 5,795

6,867

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

2007 2008 2009 2010

(Rmb'000)

Source: China BlueChem UREA Urea contributes about 50% China BlueChem’s total revenue. As the only subsidiary of CNOOC that is engaged in the fertiliser business, China BlueChem has been enjoying very stable natural gas supplies and substantial cost advantages over its competitors. More than 70% of China BlueChem’s urea production capacity has secured long-term feedstock gas supply contracts with CNOOC. The steady relationship with its parent company has enabled China BlueChem to maintain its GPM at a high level. In FY10, China BlueChem’s GPM was 38%, much higher than Sinofert’s (297 HK) 2.2% and China XLX’s (1866 HK) 16.4%. The contract prices are not subject to changes in government regulated prices. One exception is its Tianya project, which purchases natural gas from PetroChina in Inner Mongolia. The Tianye project may have to face some cost pressure if the government decides to raise the prices of natural gas. Figure 46: China BlueChem’s Gas Supplies For Urea Production

Feed stock consumption (Urea) Gas field (operator) Contract tenure

Fudao Phase I Yacheng 13—1 (CNOOC Limited) 1996—2016

Fudao Phase II Dongfang 1—1 (CNOOC Limited) 2003—2023

Tianye Changqing (PetroChina) Annual contracts

Source: China BlueChem Figure 47: Urea Utilisation

(%)

100

106

103

109

94

96

98

100

102

104

106

108

110

2007 2008 2009 2010



Figure 48: Urea Production Volume

('000 tonnes)

1,845

1,949

1,900

2,010

1,750

1,800

1,850

1,900

1,950

2,000

2,050

2007 2008 2009 2010

Source: China BlueChem Figure 49: Urea Sales Volume

('000 tonnes)

1,857

1,882

1,9581,984

1,750

1,800

1,850

1,900

1,950

2,000

2007 2008 2009 2010

Source: China BlueChem Because of China’s ban on natural gas-based fertiliser expansion plans, China BlueChem has been exploring opportunities for coal-based nitrogen fertiliser expansion. In Jul 09, China BlueChem acquired a 49% stake in Yangpoquan Coal (with 90m tonnes of coal reserve) in Shanxi. In Jul 10, China BlueChem acquired an 80% stake in Huahe Chemical in Hegang City, Heilongjiang Province. The company will utilise coal resources acquired to construct a coal and urea production base that integrates the upper and lower stream. According to management, Huahe Chemical has obtained approval to construct a 520,000 tonne p.a. urea project in Hegang City, Heilongjiang Province and also acquired a coal exploration right in Xinhua District in Hegang City, Heilongjiang Province. The Huahe project will come on stream in 1H13. This new production base will further enhance its urea production capacity and maintain its cost competitiveness. In addition, this urea production base is located within the prime regions for crop production in the northeast of China, which will optimise the layout of China BlueChem’s domestic fertiliser production bases. In 2009, China BlueChem formed Baotou Coal Chemical Corporation in Inner Mongolia to acquire coal resources in northern China for urea production.


METHANOL To cut down on fuel consumption and promote environmental protection, a lot of research has been done to probe the use of methanol in cars worldwide. Nowadays, the technologies have become mature both in technical and commercial aspects. China has already released the fuel blending national standards M85 (Methanol: Gasoline- 85:15) and M100 (pure methanol). The M15 standard, which requires no modification to the vehicles’ engines, is likely to be released soon. Figure 50: Worldwide Methanol Consumption

Formalehyde30%

MTBE, DME, Fuel34%

Others4%Medicine

6%

Pesticide6%

Esters10%

Acetic acid10%

Source: Easttop Figure 51: Methanol's Contribution To Total Revenue

Year 2006 2007 2008 2009 2010 1H2011

Revenue from Methanol (Rmbm) 309 1,146 2,044 1,220 1,691 1,682 Percentage of Total (%) 8.9 26.4 30.0 21.1 24.6 35.4

Source: China BlueChem China BlueChem adopts state-of-the-art technologies to reduce the feedstock and energy consumption. For its newly built methanol production Phase II, it uses the production systems designed by Lurgi, a leading German engineering, construction and chemical process licensing company. For Phase I, it uses the system provided by Davy Process Technology, a British chemical engineering company. Figure 52: China BlueChem’s Gas Supplies For Methanol Production

Feedstock Consumption (Methanol) Gas Field (operator) Contract Tenure

Hainan Phase I Dongfang 1—1 (CNOOC Limited) 2006-26 Hainan Phase II Ledong (CNOOC Limited) 2010-25 Tianye Changqing (PetroChina) Annual contracts

Source: China BlueChem Figure 53: Methanol Utilisation Rate

89

96

101

100

82

84

86

88

90

92

94

96

98

100

102

2007 2008 2009 2010

(%)



Figure 54: Methanol Production Volume

504

771 809867

0

100

200

300

400

500

600

700

800

900

1,000

2007 2008 2009 2010

('000 tonnes)

Source: China BlueChem Figure 55: Methanol Sales Volume

509

756802

867

0

100

200

300

400

500

600

700

800

900

1,000

2007 2008 2009 2010

('000 tonnes)

Source: China BlueChem PHOSPHATE China BlueChem entered the phosphate fertiliser business in Dec 08 by acquiring an 83.2% stake in Dayukou Chemical and 100% stake in ZHJ Mining from CNOOC. The main businesses of Dayukou Chemical and ZHJ Mining are phosphate mining and processing as well as the production and sale of phosphoric chemical products (mainly phosphate fertilisers). The DYK Chemical Company, established in Aug 05, is located in Jingmen City, Hubei Province. It is principally engaged in phosphate mining and processing, production and sales of MAP and DAP fertiliser products. It has 124m tonnes of phosphate ore, with an average grade of 19.6% P2O5, and the exploitation concession period is from 18 Apr 08 to 18 Apr 38. China BlueChem is building a 500,000 tonnes/year DAP project, which is scheduled to come on stream at end-11. The ZHJ Mining Company, established in Jul 06, is also located in Jingmen City, Hubei Province. It has a phosphate ore reserve of 36m tonnes, with the average grade of 21.6% P2O5. The exploitation period is from 5 Jun 07 to 5 Jun 36. China BlueChem now has an annual production capacity of 500,000 tonnes of phosphate fertilisers and plans to bring the DYK’s 500,000 tonnes/year DAP project on stream at end-11.


China BlueChem also has a 45% of the stake of Guizhou Jinlin Chemical Company which plans to eventually have an annual production capacity of 400,000 tonnes of phosphoric acid. Figure 56: Phosphate Utilisation Rate

9188

0

10

20

30

40

50

60

70

80

90

100

2009 2010

(%)

Source: China BlueChem Figure 57: Phosphate Production Volume

442

455

435

440

445

450

455

460

2009 2010

('000 tonnes)

Source: China BlueChem Figure 58: Phosphate Sales Volume

401

480

360

380

400

420

440

460

480

500

2009 2010

('000 tonnes)



POM POM, also known as polytrioxane or polyformaldehyde, is formed from the polymerisation of formaldehyde and is an important polyacetal resin. It is an engineering plastic used to make gears, bushings and other mechanical parts. POM is a thermoplastic with good physical and processing properties. It has the following characteristics: low relative density, good shock resistance and endurance, excellent wear resistance and corrosion-proof properties, is self lubricating and has good electrical conductivity. Products and parts made from POM are widely used in segments such as the automobile, electronics, industrial machinery and agriculture industries. Global production of POM is mainly concentrated in developed countries and regions such as the US, Western Europe and Japan. Figure 59: POM Consumption Breakdown

Industrial equipment8%

Consumer goods20%

Automobile industry15%

Others2%

Electrical and electronic

55%

Source: Journal of New Materials Seeing the huge potential and wide applications of POM as a new material, China BlueChem invested Rmb103.2m for the building of three production lines in its Tianye plant in Inner Mongolia. It is China BlueChem’s first fine chemical project, signaling the company’s entry into high value-added and more sophisticated market. The project mainly consists of three production lines: A, B and C. Line A finished its trial in Nov 10 and Line B finished its trial in Jan 11. As of Jun 11, Line A and B have produced 10,000 tonnes of POM, which was mainly supplied to the south China region. Line C also started trial run in June and produced qualified product. Major advantages over competitors in sourcing natural gas. As mentioned, the company’s biggest advantage lies in the ability to source natural gas from its parent company CNOOC at discounted price levels. Under the terms of the natural gas sale and purchase agreements, the prices are subject to upward or downward adjustments on a quarterly basis in the case of Fudao Phase I and Fudao Phase II, and on a monthly basis in the case of CNOOC Jiantao Methanol plant. The applicable quarterly or monthly price (as the case may be) is determined with reference to the prevailing crude oil price quoted by Platts Crude Oil Marketwire (which reflects the average of four major types of crude oil prices in the international market, namely of the West Texas Intermediate crude oil price, Dubai crude oil price, Brent crude oil price and Minas crude oil price in the case of Fudao Phase I; and of the West Texas Intermediate crude oil price, Tapis crude oil price, Brent crude oil price and Minas crude oil price in the case of Fudao Phase II and CNOOC Jiantao Methanol Plant).


The natural gas price for the relevant quarter or month (as the case may be) is also subject to a cap and a floor that is specified in the agreement between the two parties. The pricing mechanism has effectively helped the company to limit the impact of fuel price volatility. China BlueChem Hainan production base’s natural gas costs are not subject to the National Development and Reform Commission’s (NDRC) price regulations, while other gas-based fertiliser producers have to suffer from the authorities’ price interventions that have been pushing up the prices in recent years. The real unit cost of natural gas that China BlueChem bears is actually much lower than that of its peers. This, of course, has to do with the fact that China BlueChem enjoys special support from its parent company CNOOC. But a more important reason is that the purity of the natural gas produced from CNOOC’s Hainan gas field is only about 60% (the rest of it being CO2), much lower than that of the inland gas field (usually over 95%). The gas has a lower combustion heat value and has to be purified if it is to be used in households, thus making it very hard and uneconomical for CNOOC to sell these gases to households. This actually explains why China BlueChem can get such a discount. During our latest plant visit to its Hainan production base, we learnt that low-purity natural gas is more suitable for the production of urea and methanol and even save some costs in making urea and methanol because one integral production step is the injection of CO2. And the low-purity natural gas has certain portion of CO2.

Self-owned ports to facilitate transportation and increase competitiveness. The Basuo port is located in Donfang City, near China BlueChem’s production facilities. It has navigation trade with many domestic ports and more than 20 countries and regions in the world. China BlueChem owns more than 90% stake of Hainan Basuo Port Company. The port has been playing an important role in transporting China BlueChem’s products. The port also enables China BlueChem to reduce its transportation costs and beat its peers in terms export conveniences. Besides, since sea shipping is the least costly means of transportation, the Basuo port has enabled China BlueChem to maintain a transportation advantage over its peers. Figure 60: China BlueChem’s Self-owned Port

Source: China BlueChem, UOB Kay Hian


Risk Factors Further delays in the fertiliser sector recovery. If the pricing and sales volume recovery for fertiliser products are further delayed, China BlueChem’s earnings will be hurt. Slow sector recovery will intensify competition and hurt the company’s overall performance. Adverse weather conditions to dampen fertiliser demand. If the traditional farming season is disrupted, demand for fertilisers will be dampened, worsening the competitive situation. Economic downturn. Despite the fact that the fertiliser sector is less closely correlated with the macroeconomy, it is still subject to world economic factors in terms of fertiliser needs, fertiliser prices, etc. The current world economic uncertainties may cause the recovery for the fertiliser sector to be further delayed and hurt the company’s earnings. Shortage of natural gas supply. As mentioned, the Tianye plant in Inner Mongolia purchases natural gas from PetroChina, instead of its parent company CNOOC. It has been disclosed by the company that the plant is facing a gas shortage. One solution by the company is to build another gas pipeline to prevent the plant’s utilisation rate from being constrained. However, the operations could be negatively affected if the pipeline building gets delayed. Government support for natural gas-based fertiliser industry ebbs. In the recent two years, due to the short supply and rising price of natural gas and the Chinese government’s discouragement of using natural gas for industrial uses, a lot of fertiliser producers are increasing their proportion of coal use. As mentioned, China BlueChem has also begun to acquire coal mines. However, natural gas still takes up a rather large proportion of the company’s raw materials. The possibility that the government exerts some unfavourable policies on natural gas-based fertiliser producers cannot be ruled out.


Figure 61: Profit & Loss


Revenue, net 5,795 6,867 9,645 11,317 13,174 Operating expenses (4,512) (5,176) (6,852) (8,225) (9,633) EBIT 1,283 1,691 2,793 3,093 3,542 Associate contributions 15 (0) 70 70 70 Net interest income/(expense) 15 (5) 17 10 13 Exceptional items 0 0 0 0 0 Pre-tax profit 1,312 1,686 2,880 3,173 3,625 Tax (198) (316) (527) (683) (889) Minorities (130) (194) (334) (353) (388) Extraordinary items 0 0 0 0 0 Net profit(rep./act.) 985 1,175 2,019 2,137 2,348 Net profit(adj.) 985 1,175 2,019 2,137 2,348

Deprec. & amort. 729 744 1,154 1,307 1,476 EBITDA 2,012 2,434 3,947 4,400 5,017 Per share data (Fen) EPS - diluted 21.4 25.5 43.8 46.4 50.9 Reported EPS - diluted 21.4 25.5 43.8 46.4 50.9 Book value per shares (BVPS) 210.1 229.2 262.9 297.0 334.9 Dividend per share (DPS) 9.5 7.0 12.3 13.0 14.3

Source: China BlueChemical, UOB Kay Hian Figure 62: Balance Sheet


Cash/Near cash equiv. 1,945 2,387 2,056 2,540 3,185 Accounts receivable/debtors 109 106 131 154 179 Stocks 798 984 1,016 1,219 1,426 Other current assets 752 399 1,061 1,233 1,425 Current assets 3,604 3,876 4,264 5,146 6,215 Fixed assets 7,395 8,944 9,796 10,894 11,968 Investments 665 655 725 795 865 Other financial assets 64 78 78 78 78 Intangible assets 487 487 469 453 441 Other non-current tangible assets 431 484 596 640 711 Total non-current assets 9,042 10,649 11,665 12,861 14,064 Total assets 12,646 14,525 15,928 18,007 20,279 Accounts payable/creditors 148 223 196 236 276 Short-term debt/borrowings 0 0 0 0 0 Other current liabilities 1,304 1,802 1,489 1,763 2,042 Current liabilities 1,452 2,025 1,685 1,999 2,318 Long-term debt 1 336 426 516 606 Deferred tax liability 77 74 74 74 74 Other non-current liabilities 172 171 171 171 171 Total non-current liabilities 250 580 671 761 851 Total liabilities 1,702 2,605 2,356 2,760 3,169 Minority interest - accumulated 1,258 1,354 1,452 1,556 1,670 Shareholders' equity 9,686 10,566 12,120 13,691 15,441 Liabilities and shareholders' funds 12,646 14,525 15,928 18,007 20,279

Source: China BlueChemical, UOB Kay Hian


Figure 63: Cash Flow


Operating cashflows 1,790 1,955 2,362 3,632 4,024 Pre-tax profit 1,312 1,686 2,880 3,173 3,625 Tax (177) (236) (527) (683) (889) Deprec. & amort. 709 729 1,154 1,307 1,476 Associates (15) 0 (70) (70) (70) Working capital changes (20) (205) (1,059) (85) (104) Non-cash items (45) (19) (17) (10) (13) Others 25 0 0 0 0 Cash from investing activities (3,195) (1,378) (1,971) (2,375) (2,519) Capex (growth) (1,061) (2,281) (2,000) (2,400) (2,550) Investments (2,183) 878 0 0 0 Proceeds from sale of assets 0 0 0 0 0 Others 50 25 29 25 31 Cash from financing activities (897) (134) (723) (773) (860) Dividend payments (438) (323) (565) (598) (657) Issue of shares 0 0 0 0 0 Proceeds from borrowings 1 335 0 0 0 Loan repayment (359) (40) 91 90 90 Others/interest paid (101) (107) (248) (265) (292) Net increase/(decrease) in cash (2,302) 442 (332) 484 645 Beginning cash 4,246 1,945 2,387 2,056 2,540 Changes due to forex impact 0 0 0 0 0 End cash 1,945 2,387 2,056 2,540 3,185

Source: China BlueChemical, UOB Kay Hian Figure 64: Key Metrics

Year to 31 Dec (%) 2009 2010 2011F 2012F 2013F

Growth Turnover 5.0 18.5 40.4 17.3 16.4 EBITDA (23.2) 21.0 62.1 11.5 14.0 Pre-tax profit (35.6) 28.4 70.8 10.2 14.2 Net profit (39.8) 19.4 71.8 5.8 9.9 Net profit (adj.) n.a. 19.4 71.8 5.8 9.9 EPS (39.8) 19.4 71.8 5.8 9.9 Profitability EBITDA margin 34.7 35.5 40.9 38.9 38.1 EBIT margin 22.1 24.6 29.0 27.3 26.9 Gross margin 29.7 31.9 35.2 33.7 33.4 Pre-tax margin 22.6 24.5 29.9 28.0 27.5 Net margin 17.0 17.1 20.9 18.9 17.8 ROE 10.3 11.6 17.8 17.6 16.1 ROA 8.1 8.7 13.3 13.1 12.3 ROIC 9.8 11.5 16.5 16.4 15.0 RONTA 14.4 14.7 20.9 21.3 20.0 Leverage Interest cover (x) 432.4 451.9 323.7 291.6 279.2 Debt to total capital 0.0 2.7 3.0 3.3 3.4 Debt to equity 0.0 3.2 3.5 3.8 3.9 Net debt/(cash) to equity (20.1) (19.4) (13.4) (14.8) (16.7) Current ratio (x) 2.5 1.9 2.5 2.6 2.7

Source: China BlueChemical, UOB Kay Hian


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