In 1H17, cumulative natural gas supplied was 117bcm, up 10.7% y-o-y, as importsrose 16% y-o-y to 43bcm and domestic production increased 8% y-o-y to a recordhigh of 74bcm. We believe industrial users are increasingly dealing direct, via bothLNG direct contracts and spot, creating an uptick in LNG imports in 2017 YTD. Theexpansion of LNG imports balanced the contraction of cumulative PNG imports.    2Q17 gas demand surged 20%, including a 30% y-o-y jump in imports and a 13%increase in domestic production. Although demand is seasonally weak in June,natural gas supplied rose 30% (domestic 15% and imports 20%). Some of this likelywent to storage to increase gas availability during seasonal peak demand.    A series of documents were released, sending a strong signal to stimulate gasbusiness: In 2Q17, the NDRC issued gas marketization reform schemes including 1)a requirement for gas producers and independent operators to fully publicize detailedgas transportation costs, aiming to normalize gas transportation prices byinstitutionalizing the 7% ROI cap. The government also gave guidance on oil and gastransportation pipeline construction via a medium-term pipeline plan to 2025.    Lower prices improve gas competitiveness: In 1H17, industrial gas prices fellRMB3.31/cm or 0.10/cm y-o-y , but still lack an advantage compared to power coal,diesel and LPG in industrial activities. End-user gas prices may slip further as theShanghai Gas Trading Centre is creating a benchmark industrial LNG price, whichmay help stimulate industrial gas demand. Residential gas prices rose in 1H17, butthe impact on volumes should be minor as urban population trends are intact.    2017 outlook and demand prospects: China’s 2Q17 GDP growth beat marketexpectations at 6.9% y-o-y, and the gas demand/GDP multiplier picked up to 2.8x in2Q and 1.35x YTD. Government policies remain constructive. Stricter environmentalprotection policies incentivize local governments to accelerate the shift in industryuse of coal to gas. Demand is normally higher in the second half of the year, whichmeans the full-year demand is likely to be above 235bcm, implying 10%+ y-o-ygrowth in 2017. Breakthroughs on shale gas production and the diversification ofimport sources are both contributing to long-term gas supply security. We believeKunLun Energy (135 HK, Buy, CMP HKD7.41, TP HKD8.10, Buy) is the cleanestway to play gas in our upstream/mid-stream coverage.

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