Japan
Utilities
2 December 2008
Gas: Initiating coverage
Overweight on expectation for
greater clean energy demand
Tomohiro Jikihara
Research Analyst
(+81) 03 5156-6732
tomohiro.jikihara@db.com
Deutsche Securities Inc.
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factor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's research
is available to customers of DBSI in the United States at no cost. Customers can access IR at http://gm.db.com or by calling 1-877-
208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.
Coverage Change
Top picks
Tokyo Gas (9531.T),¥437 Buy
Osaka Gas (9532.T),¥376 Buy
Companies featured
Tokyo Gas (9531.T),¥437 Buy
2008A 2009E 2010E
EPS (¥) 15 11 40
P/E (x) 34.9 40.5 11.0
EV/EBITDA (x) 9.6 9.0 5.1
Osaka Gas (9532.T),¥376 Buy
2008A 2009E 2010E
EPS (¥) 19 14 35
P/E (x) 23.4 27.6 10.7
EV/EBITDA (x) 8.2 8.5 5.3
Global Markets Research Company
Initiating coverage with Overweight sector stance
We initiate coverage of the gas sector with an Overweight stance for the following
four reasons.
(1) Even considering a slowing economy, we expect high profit growth at the two
major gas companies in FY3/10 on a decline in crude oil prices. Based on our
crude oil price assumptions, we think Tokyo Gas and Osaka Gas are well
positioned to reach their highest RP levels in the last 10 years.
(2) We see potential for demand to increase, especially industrial demand, thanks
to laying new pipelines.
(3) We expect the trial introduction of emissions trading and other regulatory
actions to underpin rising demand for gas as a superior energy source in terms of
environmental costs.
(4) We expect good shareholder returns, please see our report on Osaka Gas, P48.
Initiate coverage of two gas companies
We initiate coverage of Tokyo Gas and Osaka Gas with Buy ratings.
Fuel a rising proportion of total costs
Osaka Gas’s fuels costs rose from 26.1% of total costs in FY3/98 to 58.5% in
FY3/08. With gas companies’ cost structures changing, we need to closely
monitor sharply swinging fuel costs when formulating profit forecasts.
Gas companies weathered deregulation through structural reforms
Gas deregulation got fully underway when the ban on retail deregulation was lifted
in 1999, and gas companies responded with sweeping cost reductions. They
maintained cost competitiveness by substantially reducing fixed costs and passing
on the benefits to consumers in the form of lower gas rates.
Gas sector to enter growth period with full introduction of emissions trading
We believe gas demand will enter a period of renewed growth driven mainly by: 1)
greater price advantages for natural gas due to a rise in crude oil prices; and 2)
forward-looking consideration of the full introduction of emissions trading (natural
gas is a fossil fuel with a low environmental impact).
Aggressive shareholder returns
Both Tokyo Gas and Osaka Gas have aggressive shareholder returns, including
dividend increases over the past three years and active share buybacks.
Valuation and risk
We value the two firms using EV/EBITDA. The six major gas companies listed on the
TSE's First Section have a weighted-average EV/EBITDA of 7.5x on FY3/08 results. We
discount this by the cost of capital to get a forward multiple and apply the result to the
weighted-average of our forecasts for the next 2 years to get target prices. Risks
include: 1) a smaller-than-expected drop in oil prices that keeps profit growth below
expectations; 2) a decrease in advantages versus crude oil and an inability to renew
contracts due to a rise in prices when renewing LNG purchasing contracts; 3)
lower gas demand than we expect due to delays in regulatory policies related to
reducing CO2 emissions and an acceleration in the economic slowdown caused by
financial market turmoil (Please see page3).

Table of Contents
Investment recommendation and valuation ................................... 3
Sector stance ............................................................................................................................3
Valuation ...................................................................................................................................3
Risks.........................................................................................................................................3
Gas deregulation ............................................................................... 4
Gas deregulation since 1995.....................................................................................................4
Is gas deregulation successful? ................................................................................................5
Cost structure .................................................................................... 6
Gas resource cost adjustment system .....................................................................................7
Average gas resource price ......................................................................................................9
Specific calculation methods ....................................................................................................9
Gas business characteristics .......................................................... 11
Operating modes ....................................................................................................................11
Gas is a stable growth industry...............................................................................................11
LNG is the bulk of raw materials cost .....................................................................................12
Ordinary gas operations are pipeline industries ......................................................................12
How LNG prices are determined ............................................................................................13
Natural gas ....................................................................................... 15
96% of Japan’s natural gas consumption is imported as LNG ...............................................15
CO2 cost and the LNG advantage................................................... 16
LNG is easier on the environment...........................................................................................16
Greenhouse gases in Japan ....................................................................................................16
CO2 recovery technologies and costs .....................................................................................19
Calculating costs .....................................................................................................................20
Comparing costs to other types of energy .............................................................................20
Case studies ...........................................................................................................................21
Company
Tokyo Gas ............................................................................................................................... 25
Osaka Gas .............................................................................................................................48