UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549












FORM 10-Q/A

(Amendment No.1)












(Mark One)

|x | QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------

For the quarterly period ended March 31, 2011



| ̈ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
|- | ---------------------------------------------------------------
|  | For the transition period from           to                    



Commission File Number: 001-34373



CHINA NATURAL
GAS, INC.

(Exact name of registrant as specified in
its charter)



|Delaware                                                               | 98-0231607                                  
|---------------------------------------------------------------------- | --------------------------------------------
|(State or other jurisdiction of
        incorporation or organization) | (I.R.S. Employer
        Identification No.)



19th Floor, Building B, Van Metropolis

35 Tang Yan Road, Hi-Tech Zone

Xi’an, 710065, Shaanxi Province, China

+86-29-8832-7391



(Address, including zip code, and telephone
number, including area code, of registrant’s principal executive offices)



Indicate by check mark whether the registrant
(1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.     Yes x No£



In dicate by check mark whether the registrant
has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted
and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter
period that the registrant was required to submit and post such files).     Yes ̈No x



Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated
filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
(Check one):

|Large accelerated filer  ̈ | Accelerated filer         | x
|------------------------- | ------------------------- | -
|Non-accelerated filer  ̈   | Smaller reporting company |  ̈



(Do not check if a smaller reporting company)



Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Exchange Act).  Yes £   No x



The number of shares outstanding of the registrant’s common
stock as of May 6, 2011 was 21,458,654.













EXPLANATORY NOTE



This Amendment No. 1 on Form 10-Q/A (the “Amended Filing”)
amends the Quarterly Report of China Natural Gas, Inc. (the “Company”) on Form 10-Q for the quarter ended March 31,
2011, originally filed on May 10, 2011 (the “Original Filing”).



As disclosed in the Company's Quarterly
Report on Form 10-Q/A (Amendment No. 3) for the quarter ended March 31, 2010, as of March 31, 2010, the Company had outstanding
balances of $9,858,240 and $4,401,000 of loan receivables, extended toMs. Taoxiang Wang
(the “Wang Loan”) and Shanxi JunTai Housing Purchase Ltd. Respectively (the “Juntai Loan”) (together with
the Wang Loan, the “Loans”).



The Company’s Board of Directors has concluded that the Wang
Loan was made to parties related to the Company’s former Chief Executive Officer and current Chairman of the Company’s
Board of Directors, Mr. Qinan Ji, for the benefit of those related parties, and that the nature of the Wang Loan had not been properly
disclosed to the Company's Board of Directors and Audit Committee, its Independent Registered Public Accounting Firm, Frazer Frost,
LLP at the time the Wang Loan was made, or its current Independent Registered Public Accounting Firm, Friedman LLP at the time
they were engaged as the Company’s new Independent Registered Public Accounting Firm in December 2010. Furthermore, neither
of the Loans were reported to or approved by the Company’s Board of Directors.



As a result, the Company filed a Current Report on Form 8-K on September
21, 2011 to disclose that its quarterly financial statements for the three months ended March 31, 2010, June 30, 2010 and September
30, 2010, respectively, and its annual financial statements for the year ended December 31, 2010, should no longer be relied upon
due to a failure to correctly disclose the Wang Loan as a related party transaction.



The purpose of this Amended Filing is to reclassify the Wang Loan
and properly disclose the related party transaction nature of the Wang Loan. The amendments herein include: (i) reclassification
of the Wang Loan from Loan Receivables to Loan Receivables – Related Party, (ii) disclosure of the related party transaction
nature of the Wang Loan; and (iii) other disclosures related to the foregoing, including additional material weaknesses in the
Company’s disclosure controls and procedures and internal control over financial reporting and certain remediation measures
related thereto.



In accordance with Rule 12b-15 under the Exchange Act, each item
of the Original Filing, that is amended by this Amended Filing is also restated in its entirety, and this Amended Filing is accompanied
by currently dated certifications on Exhibits 31.1, 31.2, 32.1 and 32.2 by the Company’s Chief Executive Officer and Chief
Financial Officer. Except as described above, this Amended Filing does not amend, update, or change any items, financial statements,
or other disclosures in the Original Filing, and does not reflect events occurring after the filing of the Original Filing, including
as to any exhibits to the Original Filing, affected by subsequent events. Information not affected by the changes described above
is unchanged and reflects the disclosures made at the time of the Original Filing. Accordingly, this Amended Filing should be read
in conjunction with the Original Filing and our other SEC filings subsequent to the filing of the Original Filing, including any
other amendments to those filings. Capitalized terms not defined in the Amended Filing are as defined by the Original Filing.











Index



|PART I.  FINANCIAL INFORMATION |                                                                                                                         |   
|------------------------------ | ----------------------------------------------------------------------------------------------------------------------- | --
|Item 1.                        | Condensed Consolidated Financial Statements (Unaudited)                                                                 |   
|                               | Condensed Consolidated Balance Sheets as of March 31, 2011 and December 31, 2010                                        |   
|                               | Condensed Consolidated Statements of Income and Comprehensive Income for the three months ended March 31, 2011 and 2010 |   
|                               | Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2011 and 2010                      |   
|                               | Notes to Condensed Consolidated Financial Statements                                                                    |   
|Item 2.                        | Management’s Discussion and Analysis of Financial Condition and Results of Operations                                   |   
|Item 3.                        | Quantitative and Qualitative Disclosures About Market Risk                                                              |   
|Item 4.                        | Controls and Procedures                                                                                                 |   
|                               |                                                                                                                         |   
|PART II. OTHER INFORMATION     |                                                                                                                         |   
|Item 1.                        | Legal Proceedings                                                                                                       |   
|Item 1A.                       | Risk Factors                                                                                                            |   
|Item 2.                        | Unregistered Sales of Equity Securities and Use of Proceeds                                                             |   
|Item 3.                        | Defaults Upon Senior Securities                                                                                         |   
|Item 4.                        | Removed and Reserved                                                                                                    |   
|Item 5.                        | Other Information                                                                                                       |   
|Item 6.                        | Exhibits                                                                                                                |   
|Signatures                     |                                                                                                                         | 44



2







CHINA NATURAL GAS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)



|                                                                                                                                         |  | March 31, |             |  | December 31, |  
|---------------------------------------------------------------------------------------------------------------------------------------- |  | --------- | ----------- |  | ------------ | -
|                                                                                                                                         |  | 2011      |             |  | 2010         |  
|                                                                                                                                         |  |           |             |  |              |  
|ASSETS                                                                                                                                   |  |           |             |  |              |  
|CURRENT ASSETS:                                                                                                                          |  |           |             |  |              |  
|Cash and cash equivalents                                                                                                                |  | $         | 8,931,164   |  |              | $
|Accounts receivable, net                                                                                                                 |  |           | 2,168,391   |  |              |  
|Other receivables                                                                                                                        |  |           | 174,251     |  |              |  
|Employee advances                                                                                                                        |  |           | 268,480     |  |              |  
|Inventories                                                                                                                              |  |           | 1,498,636   |  |              |  
|Advances to suppliers                                                                                                                    |  |           | 1,661,548   |  |              |  
|Prepaid expense and other current assets                                                                                                 |  |           | 4,903,344   |  |              |  
|Total current assets                                                                                                                     |  |           | 19,605,814  |  |              |  
|                                                                                                                                         |  |           |             |  |              |  
|Investment in unconsolidated joint ventures                                                                                              |  |           | 1,527,000   |  |              |  
|Property and equipment, net                                                                                                              |  |           | 81,602,494  |  |              |  
|Construction in progress                                                                                                                 |  |           | 131,059,823 |  |              |  
|Deferred financing cost, net                                                                                                             |  |           | 824,708     |  |              |  
|Other assets                                                                                                                             |  |           | 20,097,164  |  |              |  
|TOTAL ASSETS                                                                                                                             |  | $         | 254,717,003 |  |              | $
|                                                                                                                                         |  |           |             |  |              |  
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                     |  |           |             |  |              |  
|                                                                                                                                         |  |           |             |  |              |  
|CURRENT LIABILITIES:                                                                                                                     |  |           |             |  |              |  
|Notes payable - current maturities                                                                                                       |  | $         | 2,627,436   |  |              | $
|Long-term debt - current portion                                                                                                         |  |           | 4,581,000   |  |              |  
|Accounts payable and accrued liabilities                                                                                                 |  |           | 5,364,458   |  |              |  
|Other payable - related party                                                                                                            |  |           | 763,500     |  |              |  
|Short-term borrowing - related party                                                                                                     |  |           | 1,320,000   |  |              |  
|Unearned revenue                                                                                                                         |  |           | 1,820,699   |  |              |  
|Accrued interest                                                                                                                         |  |           | 504,675     |  |              |  
|Taxes payable                                                                                                                            |  |           | 3,311,750   |  |              |  
|Total current liabilities                                                                                                                |  |           | 20,293,518  |  |              |  
|                                                                                                                                         |  |           |             |  |              |  
|LONG TERM LIABILITIES:                                                                                                                   |  |           |             |  |              |  
|Notes payable, net of current portion                                                                                                    |  |           | 28,901,921  |  |              |  
|Long-term debt                                                                                                                           |  |           | 13,743,000  |  |              |  
|Derivative liabilities – warrants                                                                                                        |  |           | 17,635,886  |  |              |  
|Total long-term liabilities                                                                                                              |  |           | 60,280,807  |  |              |  
|Total liabilities                                                                                                                        |  |           | 80,574,325  |  |              |  
|                                                                                                                                         |  |           |             |  |              |  
|COMMITMENTS AND CONTINGENCIES                                                                                                            |  |           |             |  |              |  
|                                                                                                                                         |  |           |             |  |              |  
|STOCKHOLDERS' EQUITY:                                                                                                                    |  |           |             |  |              |  
|Preferred stock, par value $0.0001 per share, 50,000,000 authorized, none issued and outstanding                                         |  |           | -           |  |              |  
|Common stock, par value $0.0001 per share,45,000,000 authorized, 21,321,904 issued and outstanding at March 31,2011 and December 31,2010 |  |           | 2,132       |  |              |  
|Additional paid-in capital                                                                                                               |  |           | 81,772,659  |  |              |  
|Accumulative other comprehensive gain                                                                                                    |  |           | 17,115,801  |  |              |  
|Statutory reserves                                                                                                                       |  |           | 8,306,002   |  |              |  
|Retained earnings                                                                                                                        |  |           | 66,946,084  |  |              |  
|Total stockholders' equity                                                                                                               |  |           | 174,142,678 |  |              |  
|TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                               |  | $         | 254,717,003 |  |              | $



The accompanying notes are an integral part
of these unaudited condensed consolidated financial statements.



3







CHINA NATURAL GAS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND

COMPREHENSIVE INCOME

(Unaudited)



|                                    |  | For the Three Months Ended March 31, |           
|----------------------------------- |  | ------------------------------------ | ----------
|                                    |  | 2011                                 |           
|                                    |  |                                      |           
|Revenue                             |  |                                      |           
|Natural gas                         |  | $                                    | 20,347,829
|Gasoline                            |  |                                      | 1,307,174 
|Installation and other              |  |                                      | 2,453,105 
|                                    |  |                                      | 24,108,108
|                                    |  |                                      |           
|Cost of revenue                     |  |                                      |           
|Natural gas                         |  |                                      | 12,099,451
|Gasoline                            |  |                                      | 1,224,724 
|Installation and other              |  |                                      | 1,063,632 
|                                    |  |                                      | 14,387,807
|                                    |  |                                      |           
|Gross profit                        |  |                                      | 9,720,301 
|                                    |  |                                      |           
|Operating expenses                  |  |                                      |           
|Selling                             |  |                                      | 3,579,921 
|General and administrative          |  |                                      | 2,910,971 
|                                    |  |                                      | 6,490,892 
|                                    |  |                                      |           
|Income from operations              |  |                                      | 3,229,409 
|                                    |  |                                      |           
|Other income (expense)              |  |                                      |           
|Interest income                     |  |                                      | 6,649     
|Interest expense                    |  |                                      | (4,668    
|Other income                        |  |                                      | 96,956    
|Change in fair value of warrants    |  |                                      | 116,180   
|Foreign currency exchange loss      |  |                                      | (3,042    
|                                    |  |                                      | 212,075   
|                                    |  |                                      |           
|Income before income tax            |  |                                      | 3,441,484 
|                                    |  |                                      |           
|Provision for income tax            |  |                                      | 955,653   
|                                    |  |                                      |           
|Net income                          |  |                                      | 2,485,831 
|                                    |  |                                      |           
|Other comprehensive income          |  |                                      |           
|Foreign currency translation gain   |  |                                      | 1,448,655 
|Comprehensive income                |  | $                                    | 3,934,486 
|                                    |  |                                      |           
|Weighted average shares outstanding |  |                                      |           
|Basic                               |  |                                      | 21,321,904
|Diluted                             |  |                                      | 21,358,755
|                                    |  |                                      |           
|Earnings per share                  |  |                                      |           
|Basic                               |  | $                                    | 0.12      
|Diluted                             |  | $                                    | 0.12      



The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.



4







CHINA NATURAL GAS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH
FLOWS

(Unaudited)



|                                                                                   |  | For the Three Months Ended March 31, |           
|---------------------------------------------------------------------------------- |  | ------------------------------------ | ----------
|                                                                                   |  | 2011                                 |           
|                                                                                   |  |                                      |           
|CASH FLOWS FROM OPERATING ACTIVITIES:                                              |  |                                      |           
|Net income                                                                         |  | $                                    | 2,485,831 
|Adjustments to reconcile net income to net cash  provided by operating activities: |  |                                      |           
|Depreciation and amortization                                                      |  |                                      | 1,821,365 
|Provision for doubtful accounts                                                    |  |                                      | 264,367   
|Stock-based compensation                                                           |  |                                      | 160,897   
|Change in fair value of warrants                                                   |  |                                      | (116,180  
|Change in assets and liabilities:                                                  |  |                                      |           
|Accounts receivable                                                                |  |                                      | (598,060  
|Other receivables                                                                  |  |                                      | 15,304    
|Employee advances                                                                  |  |                                      | 35,837    
|Inventories                                                                        |  |                                      | (464,199  
|Advances to suppliers                                                              |  |                                      | (673,722  
|Prepaid expense and other current assets                                           |  |                                      | (580,447  
|Accounts payable and accrued liabilities                                           |  |                                      | (97,201   
|Other payables                                                                     |  |                                      | -         
|Unearned revenue                                                                   |  |                                      | (569,659  
|Accrued interest                                                                   |  |                                      | (141,855  
|Taxes payable                                                                      |  |                                      | 915,305   
|Net cash provided by operating activities                                          |  |                                      | 2,457,583 
|                                                                                   |  |                                      |           
|CASH FLOWS FROM INVESTING ACTIVITIES:                                              |  |                                      |           
|Purchase of property and equipment                                                 |  |                                      | (105,124  
|Loans to related party                                                             |  |                                      | -         
|Loans to third party                                                               |  |                                      | -         
|Repayment of loans receivable                                                      |  |                                      | -         
|Additions to construction in progress                                              |  |                                      | (4,845,643
|Prepayment on long-term assets                                                     |  |                                      | (687,313  
|Return of acquisition deposit                                                      |  |                                      | -         
|Payment for intangible assets                                                      |  |                                      | (71,138   
|Payment for land use rights                                                        |  |                                      | -         
|Net cash used in investing activities                                              |  |                                      | (5,709,218
|                                                                                   |  |                                      |           
|CASH FLOWS FROM FINANCING ACTIVITIES:                                              |  |                                      |           
|                                                                                   |  |                                      |           
|Proceeds from short-term debt and other payable, related parties                   |  |                                      | 2,081,000 
|Proceeds from long-term debt                                                       |  |                                      | -         
|Increase in restricted cash                                                        |  |                                      | -         
|Net cash provided by financing activities                                          |  |                                      | 2,081,000 
|                                                                                   |  |                                      |           
|Effect of exchange rate changes on cash and cash equivalents                       |  |                                      | 55,550    
|                                                                                   |  |                                      |           
|NET DECREASE IN CASH AND CASH EQUIVALENTS                                          |  |                                      | (1,115,085
|                                                                                   |  |                                      |           
|CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                                     |  |                                      | 10,046,249
|                                                                                   |  |                                      |           
|CASH AND CASH EQUIVALENTS, END OF PERIOD                                           |  | $                                    | 8,931,164 
|                                                                                   |  |                                      |           
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                  |  |                                      |           
|Interest paid, including capitalized interest                                      |  | $                                    | 1,406,911 
|Income taxes paid                                                                  |  | $                                    | -         
|                                                                                   |  |                                      |           
|Non-cash transactions for investing and financing activities:                      |  |                                      |           
|Construction materials transferred to Construction in progress                     |  | $                                    | 4,960,793 
|Construction in progress transferred to property and equipment                     |  | $                                    | -         
|Advances to suppliers transferred to construction in progress                      |  | $                                    | 7,480,412 
|Capitalized interest - amortization of discount of notes payable and issuance cost |  | $                                    | 1,016,146 
|Other assets transferred to construction in progress                               |  | $                                    | 545,354   



The accompanying notes are an integral part of these unaudited condensed
consolidated financial statements.



5







China Natural Gas, Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated
Financial Statements



Note 1 - Organization



Organization and Line of Business



China Natural Gas, Inc. (the ”Company,”
“our,” “us” or “we”) was incorporated in the State of Delaware on March 31, 1999. The Company
through its wholly owned subsidiaries and variable interest entity (“VIE”), Xi’an Xilan Natural Gas Co., Ltd.
(“XXNGC”) and subsidiaries of its VIE, which are located in Hong Kong, Shaanxi Province, Henan Province and Hubei Province
in the People’s Republic of China (“PRC”), engages in sales and distribution of natural gas and gasoline to commercial,
industrial and residential customers through fueling stations and pipelines, construction of pipeline networks, installation of
natural gas fittings and parts for end-users, and conversions of gasoline-fueled vehicles to hybrid (natural gas/gasoline) powered
vehicles at automobile conversion sites. The condensed consolidated balance sheets as of March 31, 2011 and December 31, 2010 and
the condensed consolidated statements of income and comprehensive income, and cash flows for the three months ended March 31, 2011
and 2010 include the accounts of China Natural Gas, Inc. and subsidiaries and VIE.  Our subsidiaries are: Xilan Energy
Co. Ltd. (“XEC”), Shaanxi Xilan Natural Gas Equipment Co. Ltd (“SXNGE”), Hubei Xian Natural Gas Co., Ltd
(“HBXNG”), Lingbao Yuxi Natural Gas Co. Ltd. (“LYNG”), Shaanxi Jingbian Liquefied Natural Gas Co. Ltd (“JBLNG”),
Henan Xilan Natural Gas Co. Ltd (“HXNGC”), Xi’an Xilan Auto Body Shop Co, Ltd. (“XXABC”), Henan CNPC
Kunlun Xilan Compressed Natural Gas Co., Ltd (“JV”) and Hanchuan Makou Yuntong Compressed Natural Gas Co., Ltd (“Makou”).



Note 2 – Restatement of Previously Reported Consolidated
Financial Statement



The Company is hereby restating its quarterly consolidated financial
statements as of March 31, 2011, originally filed on May 10, 2011 (the “Original Filing”), to make appropriate disclosure
of the related party transaction nature of certain unauthorized loan made by the Company, and reclassify the loan into appropriate
account in the consolidated financial statements and revise the description in the notes to such financial statements..



As disclosed in the Company's Quarterly Report on Form 10-Q/A (Amendment
No. 3) for the quarter ended March 31, 2010, as of March 31, 2010, the Company had outstanding balances of $9,858,240 and $4,401,000
of loan receivables, extended to Ms. Taoxiang Wang (the “Wang Loan”) and Shanxi JunTai Housing Purchase Ltd. Respectively
(the “Juntai Loan”) (together with the Wang Loan, the “Loans”). The Company’s Board of Directors
has concluded that the Wang Loan was made to parties related to the Company’s Chief Executive Officer and Chairman of the
Company’s Board of Directors, Mr. Qinan Ji, for the benefit of those related parties, and that the nature of the Wang Loan
had not been properly disclosed to the Company's Board of Directors and Audit Committee, its Independent Registered Public Accounting
Firm, Frazer Frost, LLP at the time the Wang Loan was made, or its current Independent Registered Public Accounting Firm, Friedman
LLP at the time they were engaged as the Company’s new Independent Registered Public Accounting Firm in December 2010. Furthermore,
neither of the Loans (defined below) were reported to or approved by the Company’s Board of Directors.



The Company’s Board of Directors made a decision to restate
the consolidated financial statements upon the recommendation of the Audit Committee and management. The general nature and scope
of the adjustments are summarized as follows:



|(1) | Disclosure of related party transaction nature and reclassification of loans receivable ——Xi’an Demaoxing Real Estate Co., Ltd. (“Demaoxing”) was formed in November 2007 by relatives of Mr. Qinan Ji, the Company’s Chief Executive Officer and Chairman of the Company’s Board of Directors (the “Demaoxing Promoters”). In January 2010, Shaanxi Xilan Natural Gas Equipment Co., Ltd.  (“SXNGE”), one of the Company’s major subsidiaries, extended a loan of US$9,858,240 to Ms. Taoxiang Wang (the “Wang Loan”), who obtained a 40% ownership interest in Demaoxing on January 21, 2010. Ms. Taoxiang Wang used her 40% ownership interest in Demaoxing and its assets as collateral for the Wang Loan. On January 21, 2010, the Demaoxing Promoters also transferred 30% of their ownership interests in Demaoxing to Shaanxi Rongxin Real Estate Co., Ltd. (“Rongxin”). On January 26, 2010, the Wang Loan funds were remitted by SXNGE to an account of Demaoxing. The Board of Directors has determined that the Demaoxing Promoters retained indirect beneficial interests in Demaoxing after transferring their ownership interests and thus the Wang Loan was a related party transaction. The Company herein makes appropriate disclosures of the related party transaction nature of the Wang Loan and reclassifies the Wang Loan from Loans Receivable to Loans Receivable – Related Party throughout its quarterly consolidated financial statements for the three months ended March 31, 2011.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In the statement of cash flows for the three months ended March
31, 2011, the following reclassification is made to the amounts for the three months ended March 31, 2010:



|(1) | The item Loan Receivable of $14,259,140 is reclassified into two items, which are Loans to Related Party of $9,858,171 and Loans to Third Party of $4,400,969, respectively.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Note 3 – Summary of Significant Accounting
Policies



Basis of Presentation



The accompanying condensed consolidated financial
statements have been prepared in conformity with the accounting principles generally accepted in the United States of America (“U.S.
GAAP”).



The condensed consolidated financial statements
include all adjustments necessary to present fairly the condensed consolidated financial position, results of operations and cash
flows of the Company for the periods presented. The results of operations for the three months ended March 31, 2011 are not necessarily
indicative of operating results expected for the full year or future interim periods. These unaudited condensed consolidated financial
statements should be read in conjunction with the audited financial statements and notes thereto included in the Company's Annual
Report on Form 10-K for the year ended December 31, 2010, filed on March 14, 2011(the "2010 Annual Report").



6







Use of Estimates and assumptions



The preparation of the condensed consolidated
financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period. Significant accounting estimates reflected in the
Company’s condensed consolidated financial statements include revenue recognition, allowance for doubtful accounts, inventory
obsolescence, warrants liability and useful lives of property and equipment. Actual results could differ from those estimates.



Principles of Consolidation



The accompanying condensed consolidated financial
statements include the accounts of the Company and its wholly owned subsidiaries and its 100% VIE, XXNGC, and XXNGC’s
wholly owned subsidiaries.  All inter-company accounts and transactions have been eliminated in consolidation.



Consolidation of Variable Interest Entity



In accordance with accounting standard regarding
consolidations, VIEs are entities that lack sufficient equity to finance their activities without additional financial support
from other parties or whose equity holders lack adequate decision-making ability. Any VIE with which the Company is involved must
be evaluated to determine the primary beneficiary of the risks and rewards of the VIE.



Foreign Currency Translation



The Company’s reporting currency is the
U.S. dollar. The functional currency of XXNGC and the Company’s and XXNGC’s PRC subsidiaries, and therefore the functional
currency of the Company, is the RMB. The results of operations and financial position of XXNGC and the Company’s and XXNGC’s
PRC subsidiaries are translated to U.S. dollars using the period end exchange rates as to assets and liabilities and weighted average
exchange rates as to revenues, expenses and cash flows. Capital accounts are translated at their historical exchange rates when
the capital transaction occurred. The resulting currency translation adjustments are recorded as a component of accumulated other
comprehensive income (loss) within stockholders’ equity.



The balance sheet amounts, with the exception
of equity, were translated at the March 31, 2011 exchange rate of RMB 6.55 to $1.00 as compared to RMB 6.82 to $1.00 at March 31,
2010. The equity accounts were stated at their historical rate. The average translation rates applied to income and cash flow statement
amounts for the three months ended March 31, 2011 and 2010 were RMB 6.57 and RMB 6.82 to $1.00, respectively.



Accounts Receivable



Accounts receivable are presented net of an
allowance for doubtful accounts.  The Company estimates an allowance for potential credit losses on accounts receivable. Management
periodically reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer
credit-worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of the allowance.



7







Management considers accounts past due after
three months. Delinquent account balances are written off after management has determined that the likelihood of collection is
not probable, and known bad debts are written off against allowance for doubtful accounts when identified. The Company recorded
allowances for doubtful accounts in the amount of $280,512 and $15,177 as of March 31, 2011 and December 31, 2010, respectively.



Inventories



Inventories are stated at the lower of cost
or market, as determined on a first-in, first-out basis. Management compares the cost of inventories with the market value,
and an allowance is made for writing down the inventories to their market value, if lower. Inventories consist of material used
in the construction of pipelines and material used in repairing and modifying vehicles.  Inventories also consist of
gasoline.



The following are the details of the inventories:



|                       |  | March 31, 2011 |           |  | December 31, 2010 |  
|---------------------- |  | -------------- | --------- |  | ----------------- | -
|Materials and supplies |  | $              | 1,079,701 |  |                   | $
|Finished goods         |  |                | 418,935   |  |                   |  
|                       |  | $              | 1,498,636 |  |                   | $



Investments in Unconsolidated Joint Ventures



Investee companies that are not required to
be consolidated, but over which the Company exercises significant influence, are accounted for under the equity method of accounting.
Whether or not the Company exercises significant influence with respect to an investee depends on an evaluation of several factors
including, among others, representation on the investee company’s board of directors and ownership level, which is generally
a 20% to 50% interest in the voting securities of the investee company. Under the equity method of accounting, the Company’s
share of the earnings or losses of the investee company is reflected in the caption ”other income (expense),” in the
consolidated statements of income and comprehensive income.



The Company’s investment in unconsolidated
joint ventures that are accounted for on the equity method of accounting represents the Company’s 49% interest in the JV.
The investment in the JV amounted to $1,527,000 and $1,517,000 at March 31, 2011 and December 31, 2010, respectively. The JV has
not had any operations to date.



The financial position of the JV is summarized
below:



|                             |  | March 31, 2011 |           |  | December 31, 2010 |  
|---------------------------- |  | -------------- | --------- |  | ----------------- | -
|Current assets               |  | $              | 3,116,327 |  |                   | $
|Total assets                 |  | $              | 3,116,327 |  |                   | $
|Equity                       |  | $              | 3,116,327 |  |                   | $
|Total liabilities and equity |  | $              | 3,116,327 |  |                   | $



8







Property and Equipment



Property and equipment are stated at cost.
Expenditures for maintenance and repairs are charged to earnings as incurred while additions, renewals and betterments are capitalized.  Depreciation
of property and equipment is provided using the straight-line method for substantially all assets with estimated lives as follows:



|Office equipment           | 5 years   
|-------------------------- | ----------
|Operating equipment        | 5-20 years
|Vehicles                   | 5 years   
|Buildings and improvements | 5-30 years



|                              |  | March 31, 2011 |             |   | December 31, 2010 |  
|----------------------------- |  | -------------- | ----------- | - | ----------------- | -
|                              |  |                |             |   |                   |  
|Office equipment              |  | $              | 616,999     |   |                   | $
|Operating equipment           |  |                | 71,674,140  |   |                   |  
|Vehicles                      |  |                | 3,361,853   |   |                   |  
|Buildings and improvements    |  |                | 28,045,318  |   |                   |  
|Property and equipment        |  |                | 103,698,310 |   |                   |  
|Less accumulated depreciation |  |                | (22,095,816 | ) |                   |  
|Property and equipment, net   |  | $              | 81,602,494  |   |                   | $



Depreciation expense for the three months ended
March 31, 2011 and 2010 was $1,811,805 and $1,470,826, respectively.



Construction in Progress



Construction in progress consists of the cost
of constructing property and equipment for compressed natural gas (“CNG”) fueling stations and liquefied natural gas
(“LNG”) projects, a natural gas infrastructure project in the Xi’an International Port District and other projects,
including technology licensing fees, equipment purchases, land use rights requisition cost, capitalized interest and other construction
fees. No depreciation is provided for construction in progress until such time as the assets are completed and placed into service.
Interest incurred during construction is capitalized into construction in progress. All other interest is expensed as incurred.



As of March 31, 2011 and December
31, 2010, the Company had construction in progress in the amount of $131,059,823 and $116,569,871, respectively. Interest cost
(amortization of discount on notes payable and issuance costs) capitalized into construction in progress for the three months ended
March 31, 2011 and 2010 amounted to $1,016,146 and $863,662, respectively.



9







Construction in progress at March 31, 2011
and December 31, 2010 is set forth in the table below. The column of “estimated additional cost to complete” reflects
the amounts currently estimated by management to be necessary to complete the relevant project. As of March 31, 2011,
the Company was not contractually or legally obligated to expend the estimated additional cost to complete these projects, except
to the extent reflected in Note 12 to these condensed consolidated financial statements.





|Project Description              |  | Location                                |  | March 31,
        2011 |             |     | Commencement
        date |               | Expected
        completion
        date |               |  | Estimated
        additional cost to
        complete |  
|-------------------------------- |  | --------------------------------------- |  | ---------------------- | ----------- | --- | ------------------------- | ------------- | ---------------------------------------- | ------------- |  | ----------------------------------------------------- | -
|Phase I of LNG
        Project   |  | Jingbian County, Shaanxi Province, PRC  |  | $                      | 66,821,211  | (1) |                           | December 2006 |                                          | June 2011(2)  |  |                                                       | $
|Phases II and III of LNG Project |  | Jingbian County, Shaanxi Province, PRC  |  |                        | 38,024,647  | (4) |                           | December 2006 |                                          | December 2015 |  |                                                       |  
|Sa Pu Mother Station             |  | Henan Province, PRC                     |  |                        | 945,686     |     |                           | July 2008     |                                          | Various       |  |                                                       |  
|International Port(6)            |  | International Port District, Xi’an, PRC |  |                        | 5,476,379   |     |                           | May 2009      |                                          | December 2020 |  |                                                       |  
|Other projects                   |  | PRC                                     |  |                        | 19,791,900  |     |                           | Various       |                                          | Various       |  |                                                       |  
|                                 |  |                                         |  | $                      | 131,059,823 |     |                           |               |                                          |               |  |                                                       | $







|Project Description              |  | Location                                |  | December 31,
        2010 |             | Commencement
        date |               | Expected
        completion
        date |               |  | Estimated
        additional cost to
        complete |  
|-------------------------------- |  | --------------------------------------- |  | ------------------------- | ----------- | ------------------------- | ------------- | ---------------------------------------- | ------------- |  | ----------------------------------------------------- | -
|Phase I of LNG
        Project   |  | Jingbian County, Shaanxi Province, PRC  |  | $                         | 65,309,335  |                           | December 2006 |                                          | June 2011     |  |                                                       | $
|Phases II and III of LNG Project |  | Jingbian County, Shaanxi Province, PRC  |  |                           | 35,860,914  |                           | December 2006 |                                          | December 2015 |  |                                                       |  
|Sa Pu Mother Station             |  | Henan Province, PRC                     |  |                           | 925,328     |                           | July 2008     |                                          | June 2011     |  |                                                       |  
|International port)              |  | International Port District, Xi’an, PRC |  |                           | 5,440,515   |                           | May 2009      |                                          | December 2020 |  |                                                       |  
|Other projects                   |  | PRC                                     |  |                           | 9,033,779   |                           | Various       |                                          | Various       |  |                                                       |  
|                                 |  |                                         |  | $                         | 116,569,871 |                           |               |                                          |               |  |                                                       | $





|(1) | Includes $58,226,510 of construction cost and $8,594,701 of capitalized interest for Phase I of the LNG Project.
|--- | ----------------------------------------------------------------------------------------------------------------



|(2) | The Company has completed the trial run in December 2010. Currently, we are in the production preparation period.
|--- | -----------------------------------------------------------------------------------------------------------------



10







|(3) | Includes $814,319 of construction cost and $936,423 of capitalized interest that the Company currently expects to expend to complete test runs and make installment payments to contractors. The total expected cost of $68.57 million exceeds the amount originally anticipated by the Company. The increased costs to build a LNG processing capacity of 500,000 cubic meters are attributable to unforeseen cost overruns and escalations, including increases in material and labor costs incurred to reinforce pilings based upon modified engineering analyses, as well as rising land use rights prices, which the Company believes resulted from recent energy resource exploration activities in nearby areas. Phase I construction has also experienced delays due to changes in government policies with respect to tariff exemptions for core equipment imported by the Company and related additional document requirements of the customs agency of Shaanxi Province, and increased international shipment times for ordered equipment due to the modification by international shipping companies of traditional shipment routes to avoid pirates along the Coast of Somalia.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) | Includes $33,133,828 of construction cost and $4,890,820 of capitalized interest for Phases II and III of the LNG project.
|--- | --------------------------------------------------------------------------------------------------------------------------



|(5) | This amount reflects management’s current estimate that an investment in Phases II and III through December 31, 2015, including an estimated $186.8 million of construction cost and $20 million of capitalized interest, may be able to finance the construction of a facility capable of processing 3,000,000 cubic meters of LNG per day, or approximately 900 million cubic meters per year.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(6) | Xi’an International Port District Committee, a local government agency in the PRC, has appointed XXNGC pursuant to a conditional non-binding agreement to be the developer of natural gas infrastructure for Xi’an International Port District, a former agricultural area that has been zoned for urbanization. If XXNGC chooses to proceed with the project, it will be responsible for constructing, and all costs related to the construction of, a natural gas pipeline network that will service residential, commercial and industrial buildings and users, as well as fueling stations and related infrastructure. The estimated cost to complete the project of $299,400,000 is based upon a third-party feasibility study and management’s current estimates. The Company is currently the only natural gas provider in the surrounding area and expects that it would supply natural gas to the International Port District once construction is completed. If the Company determines not to proceed further with this project, it expects to be able to obtain a refund from subcontractors of the $5,476,379 invested as of March 31, 2011 or transfer the construction-in-progress assets.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Long-Lived Assets



The Company evaluates the carrying value of
long-lived assets to be held and used whenever events or changes in circumstances indicate that the assets might be impaired. Impairment
losses are recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets' carrying amounts. In that event, a loss is recognized
based on the amount by which the carrying amount exceeds the fair market value of the long-lived assets.  Loss on long-lived
assets to be disposed of is determined in a similar manner, except that fair market values are reduced for the cost of disposal.  Based
on its review, the Company believes that, as of March 31, 2011, there were no significant impairments to its long-lived assets.



11







Fair Value of Financial Instruments



The accounting standards regarding fair value
of financial instruments and related fair value measurements define fair value, establish a three-level valuation hierarchy for
disclosures of fair value measurement, and provide disclosure requirements for fair value measures. The carrying amounts reported
in the condensed consolidated balance sheets for current receivables and payables qualify as financial instruments. Management
concluded the carrying values are a reasonable estimate of fair value because of the short period of time between the origination
of such instruments and their expected realization and, if applicable, their stated interest rate approximates current rates available.
The three levels are defined as follows:



| | ● | Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
| | - | ---------------------------------------------------------------------------------------------------------------------------------



| | ● | Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | ● | Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.
| | - | -----------------------------------------------------------------------------------------------------------



The accounting standard regarding derivatives
and hedging specifies that a contract that would otherwise meet the definition of a derivative but is both (a) indexed to the Company’s
own stock and (b) classified to stockholders’ equity in the statement of financial position would not be considered a derivative
financial instrument. This FASB accounting standard also provides a new two-step model to be applied in determining whether a financial
instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for the exception.



As a result of adopting this accounting standard,
383,654 warrants previously treated as equity pursuant to the derivative treatment exemption are no longer afforded equity treatment
because the strike price of the warrants is denominated in U.S. dollars, a currency other than the Company’s functional currency,
the RMB. As a result, the warrants are not considered indexed to the Company’s own stock and, as such, all future changes
in the fair value of these warrants will be recognized in earnings until such time as the warrants are exercised or expire.



The fair value of the warrants was $135,886
and $252,066 as of March 31, 2011 and December 31, 2010, respectively. The Company recognized a gain of $116,180 and $393,068 for
the three months ended March 31, 2011 and 2010, respectively, to reflect the change in fair value of the warrants.



These common stock purchase warrants do not
trade in an active securities market and, as such, the Company estimates the fair value of these warrants using the Black-Scholes
Option Pricing Model, using the following assumptions:



|                        |  | March 31, 2011 |       |   | December 31,2010 | 
|----------------------- |  | -------------- | ----- | - | ---------------- | 
|Annual dividend yield   |  |                | -     |   |                  | 
|Expected life (years)   |  |                | 1.58  |   |                  | 
|Risk-free interest rate |  |                | 0.59  | % |                  | 
|Expected volatility     |  |                | 62.46 | % |                  | 



12







The following table sets forth by level within
the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value on a recurring
basis as of March 31, 2011.



|                                |  | Carrying Value at |            |  | Fair Value Measurement at |  
|------------------------------- |  | ----------------- | ---------- |  | ------------------------- | -
|                                |  | March             |            |  | March 31, 2011            |  
|                                |  | 31, 2011          |            |  | Level 1                   |  
|Senior notes                    |  |                   | 31,529,357 |  |                           |  
|Redeemable liability – warrants |  |                   | 17,500,000 |  |                           |  
|Derivative liability – warrants |  |                   | 135,886    |  |                           |  
|                                |  | $                 | 49,165,243 |  |                           | $



Other than the assets and liabilities set forth
in the table above, the Company did not identify any other assets or liabilities that are required to be accounted for at fair
value on the balance sheet. The carrying value of long-term debt with variable interest rate approximates its fair value.



The following is a reconciliation of the beginning
and ending balance of warrants liability measured at fair value on a recurring basis using significant observable inputs (Level
2) as of March 31, 2011:

|Beginning balance    |  | $ | 252,066  |  
|-------------------- |  | - | -------- | -
|Change in fair value |  |   | (116,180 | )
|Ending balance       |  | $ | 135,886  |  



Revenue Recognition



Revenue is recognized when services are rendered
to customers and when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant
obligations of the Company exist and collectability is reasonably assured. Payments received before all of the relevant criteria
for revenue recognition are satisfied are recorded as unearned revenue. Revenue from gas and gasoline sales is recognized when
gas and gasoline is pumped through pipelines to the end users. Revenue from installation of pipelines is recorded when the contract
is completed and accepted by the customers. Construction contracts are usually completed within one to two months. Revenue from
repairing and modifying vehicles is recorded when services are rendered to and accepted by the customers.



Income Taxes



FASB’s accounting standard regarding
income taxes requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events
that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for
the tax consequences in future years of temporary differences between the tax bases of assets and liabilities and their financial
reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences
are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the
amount expected to be realized. As at March 31, 2011 and December 31, 2010, there were no significant book to tax differences
except for warrants liability and stock based compensation. An uncertain tax position is recognized as a benefit only if it is
“more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being
presumed to occur. Penalties and interest incurred related to underpayment of income tax are classified as income tax expense in
the year incurred. No significant penalties or interest relating to income taxes have been incurred during the three months ended
March 31, 2011 and 2010. Income tax returns for the years prior to 2007 are no longer subject to examination by tax authorities.



13







The estimated tax savings for the three months
ended March 31, 2011 and 2010 amounted to approximately $487,694 and $498,624, respectively. The net effect on earnings per share
had the income tax been applied would decrease basic earnings per share from $0.19 to $0.17, and the diluted earnings per share
from $0.19 to $0.16 for the three months ended March 31, 2010. For the three months ended March 31, 2011, the basic and diluted
earnings per share would decrease from $0.12 to $0.09 if the income tax had been applied.



China Natural Gas, Inc. was incorporated in
the United States and has incurred net operating loss for income tax purpose for the period ended March 31, 2011.  The estimated
net operating loss carry-forwards for United States income tax purposes amounted to $6,267,768 as of March 31, 2011, which may
be available to reduce future years' taxable income. These carry-forwards will expire, if not utilized, beginning in 2027 through
2031. Management believes that the realization of the benefits arising from this loss appear to be uncertain due to Company's limited
operating history and continuing losses for U.S. income tax purposes. Accordingly, the Company has provided a 100% valuation
allowance at March 31, 2011. Management reviews this valuation allowance periodically and makes adjustments as warranted. The valuation
allowances were as follows:

|Valuation allowance          |  | For the three months ended March 31, 2011 |           |  | Year ended December 31, 2010 |  
|---------------------------- |  | ----------------------------------------- | --------- |  | ---------------------------- | -
|Balance, beginning of period |  | $                                         | 759,872   |  |                              | $
|Increase                     |  |                                           | 1,371,169 |  |                              |  
|Balance, end of period       |  | $                                         | 2,131,041 |  |                              | $



The Company has cumulative undistributed earnings
of foreign subsidiaries of approximately $48,212,872 as of March 31, 2011, which is included in consolidated retained earnings
and will continue to be indefinitely reinvested in international operations. Accordingly, no provision has been made for U.S. deferred
taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would
have to be provided if the Company concluded that such earnings will be remitted in the future.



Local PRC Income Tax



The Company’s PRC subsidiary, XXNGC and
XXNGC’s subsidiaries operate in the PRC. Pursuant to the tax laws of PRC, general enterprises are subject to income tax at
an effective rate of 25% compared to 33% prior to 2008. However, under PRC income tax regulation, any company deemed to be engaged
in the natural gas industry under such regulation enjoys a favorable income tax rate. Thus, XXNGC’s income is subject to
a reduced tax rate of 15%. The Company’s PRC subsidiary and all of XXNGC’s subsidiaries are not deemed to be engaged
in the natural gas industry under PRC income tax regulation and, accordingly, are subject to a 25% income tax rate.



14









Basic and Diluted Earnings per Share



Basic net earnings per share are based upon
the weighted average number of common shares outstanding. Diluted net earnings per share are based on the assumption that all dilutive
convertible shares and stock options were converted or exercised, unless this results in anti-dilution. Dilution is computed by
applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the
period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average
market price during the period.



Note 4 – Other Assets



Other Assets consisted of the following:



|                                                              |  | March 31, 2011 |            |  | December 31, 2010 |  
|------------------------------------------------------------- |  | -------------- | ---------- |  | ----------------- | -
|Prepaid rent – natural gas stations                           |  | $              | 2,288,583  |  |                   | $
|Goodwill                                                      |  |                | 610,925    |  |                   |  
|Prepayment for acquiring land use right                       |  |                | 4,458,840  |  |                   |  
|Advances on purchasing equipment and construction in progress |  |                | 2,942,309  |  |                   |  
|Refundable security deposits                                  |  |                | 2,641,319  |  |                   |  
|Intangible assets                                             |  |                | 7,155,188  |  |                   |  
|                                                              |  | $              | 20,097,164 |  |                   | $



The goodwill amount is the excess of the cost
the Company paid to acquire 100% of the equity interests of Makou over the fair value of Makou’s net assets. Annual impairment
testing is performed during the fourth quarter of each year unless events or circumstances indicate earlier impairment testing
is required. No impairment loss was recognized during the three months ended March 31, 2011.



All land in the PRC is government owned. However,
the government grants users land use rights. As of March 31, 2011 and December 31, 2010, the Company prepaid $4,458,840 and $3,822,840,
respectively, to PRC local government authorities to purchase land use rights. The Company is in the process of negotiating the
final purchase prices with the relevant local governments and the land use rights have not yet been granted to the Company. Therefore,
the Company did not amortize the amounts prepaid for land use rights.



Advances on the purchase of equipment and construction
in progress are monies deposited or advanced to outside vendors or subcontractors for the purchase of operating equipment or for
services to be provided for construction in progress.



Refundable security deposits are monies deposited
with one of the Company’s major vendors and a gas station landlord. These amounts will be returned to the Company if the
other party terminates the business relationship or upon the expiration of the lease.



|Intangible assets | Estimated useful lives
|----------------- | ----------------------
|Land use rights   | 30 years              



15







Intangible assets represent operating rights
acquired during acquisition of four natural gas stations, and consist of the following:



|                 |  | March 31, 2011 |           |  | December 31, 2010 |  
|---------------- |  | -------------- | --------- |  | ----------------- | -
|Operating rights |  | $              | 5,065,716 |  |                   | $
|Land use rights  |  |                | 2,089,472 |  |                   |  
|                 |  | $              | 7,155,188 |  |                   | $



The operating rights are deemed to have an
indefinite useful life as cash flows are expected to continue indefinitely.  The operating rights will not be amortized
until their useful life is deemed to be no longer indefinite. The Company evaluates intangible assets for impairment at least annually
and whenever events or changes in circumstances indicate that the assets might be impaired.



The land use rights included in intangible
assets have been granted to the Company by the PRC government and are being amortized over their estimated useful life
of 30 years.



Note 5 – Notes Payable



The Company’s securities purchase agreement
with Abax Lotus Ltd. (“Abax”) was amended on January 29, 2008 (as amended, the “Purchase Agreement”). Under
the Purchase Agreement, on January 29, 2008, the Company sold to Abax $20,000,000 in principal amount of its 5.0% Guaranteed Senior
Notes due January 30, 2014 (the “Senior Notes”) and warrants to purchase 1,450,000 shares of its common stock (the
“Abax Warrants”) and, on March 3, 2008, the Company issued to Abax an additional $20,000,000 in principal amount of
Senior Notes.



On the dates set forth in the table below,
the Company will be required to make repayments of the corresponding percentage of the principal amount (or such lesser principal
amount as shall be outstanding then) in respect of the aggregate outstanding principal amount of the Senior Notes:





|Date             |  | Repayment Percentage |        
|---------------- |  | -------------------- | -------
|July 30, 2011    |  |                      | 8.3333 
|January 30, 2012 |  |                      | 8.3333 
|July 30, 2012    |  |                      | 16.6667
|January 30, 2013 |  |                      | 16.6667
|July 30, 2013    |  |                      | 25.0000
|January 30, 2014 |  |                      | 25.0000





Notes payable at March 31, 2011 consists of the following:



|Notes payable        |  | $ | 40,000,000 |  
|-------------------- |  | - | ---------- | -
|Less discount        |  |   | (8,470,643 | )
|                     |  |   | 31,529,357 |  
|Less current portion |  |   | (2,627,436 | )
|                     |  | $ | 28,901,921 |  



16







The Company has the option to redeem all, but
not less than all, of the Senior Notes at the redemption prices set forth below (in each case expressed as a percentage of the
outstanding unpaid principal amount), plus accrued and unpaid interest, if redeemed during the twelve-month period commencing on
January 29 of the years set forth below:



|Year                |  | Principal |           
|------------------- |  | --------- | ----------
|2011                |  | $         | 41,600,000
|2012                |  | $         | 40,800,000
|2013 and thereafter |  | $         | 40,000,000



Upon the occurrence of certain events defined
in the indenture, the Company must offer the holders of the Senior Notes the right to require the Company to purchase the Senior
Notes in an amount equal to 105% of the aggregate principal amount purchased plus accrued and unpaid interest on the Senior Notes
purchased.



The terms of the Indenture obligated the Company
to complete a qualifying listing, as defined therein, by January 29, 2009. As the Company did not complete a qualifying listing
by such date, the Company was obligated to pay to Abax an additional interest at the rate of 3.0% per annum, calculated from and
including January 29, 2009 to the date of its qualifying listing. However, Abax caused the Trustee to waive the Company’s
obligation to pay such additional interest in February 2009. The waiver extended the deadline for a qualifying listing to May 4,
2009, but provided that if a qualifying listing were not completed by such date, additional interest of 3.0% per annum would be
payable from January 29, 2009 to the date of the Company’s qualifying listing. The Company completed its NASDAQ listing,
which constituted a qualifying listing, on June 1, 2009, after the extended deadline of May 4, 2009. Therefore, under the terms
of the initial waiver, the Company was required to pay additional interest at a rate of 3.0% per annum for the period from January
29, 2009 to June 1, 2009, or $406,667. However, in August 2009, the Company reached an agreement with Abax whereby the Company
agreed to pay Abax $113,214, which reflected additional interest at the rate of 3.0% per annum for the period from April 30, 2009
to May 31, 2009, and $50,000, which reflected out-of-pocket expenses incurred by Abax in connection with a financing transaction
proposed in 2008, but never consummated.



The indenture limits the Company’s ability
to incur debt and liens, make dividend payments and stock repurchases, make investments, reinvest proceeds from asset sales and
enter into transactions with affiliates, among other things. The indenture also requires the Company to maintain certain financial
ratios.



In connection with the issuance of the Senior
Notes, the Company paid $2,122,509 in debt issuance costs, which are being amortized over the life of the Senior Notes. For
the three months ended March 31, 2011 and 2010, the Company amortized $102,458 of the issuance costs in each of the periods, which
were recorded as capitalized interest included in construction in progress.



The Abax Warrants are presently exercisable
and have an exercise price of $7.37 per share, although Abax has not exercised any of the Abax Warrants.



17







The Abax Warrants are considered derivative
instruments required to be bifurcated from the original security because there is a redemption requirement if the holder does not
exercise the Warrants. If Abax does not exercise the Abax Warrants prior to their expiration date, January 29, 2015, Abax can require
the Company to repurchase the Abax Warrants for $17,500,000. This amount is shown as a debt discount and is being amortized over
the term of the Senior Notes. For the three months ended March 31, 2011 and 2010, the Company amortized $913,688 and $761,204
of the discounts, which were capitalized into construction in progress.



Note 6 – Long-term Loan



The Company’s long-term debt as of March
31, 2011 consists of:



|A loan from Pudong Development Bank Xi’an Branch, due various dates from 2012 to 2014. With interest at 5.76% for the first year and subject to adjustment after the second year. |  | $ | 18,324,000 |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | - | ---------- | -
|Less current portion                                                                                                                                                              |  |   | (4,581,000 | )
|                                                                                                                                                                                  |  | $ | 13,743,000 |  



The loan was secured by XXNGC’s equipment
and vehicles located within the PRC. The carrying net value of the assets pledged is $11,900,776 as of March 31, 2011. Interest
expense for the three months ended March 31, 2011 was $282,765, all of which was capitalized into construction in progress(6.22%
at March 31, 2011). XXNGC also entered into a guaranty with the lender to guarantee the repayment of the loans. As the People’s
Bank of China adjusted the standard interest rate two times in February and April, 2011, beginning January 1, 2012 the interest
rate of these loans is 6.65%. The Company is required to make mandatory repayments on the long term loan as follows:





|                 |  | Repayment
        Percentage |    |   | Repayment
        Amount |  
|---------------- |  | ---------------------------- | -- | - | ------------------------ | -
|March 5, 2012    |  |                              | 25 | % |                          | $
|March 5, 2013    |  |                              | 25 | % |                          |  
|March 5, 2014    |  |                              | 25 | % |                          |  
|December 5, 2014 |  |                              | 25 | % |                          |  
|                 |  |                              |    |   |                          | $





Note 7 – Warrants



No warrants were granted, forfeited or exercised during the three
months ended March 31, 2011.



The following is a summary of warrants outstanding
and exercisable as of March 31, 2011:



|Warrants Outstanding and Exercisable |      
|------------------------------------ | -----
|Exercise Price                       |      
|$                                    | 14.86
|$                                    | 7.37 



18









Note 8 – Defined Contribution Plan



The Company is required to participate in a
defined contribution plan operated by the local municipal government in accordance with PRC law and regulations.  The
Company contributes RMB 100 per employee per month to the plan.  The total contribution for the above plan was $100,370 and
$190,348 for the three months ended March 31, 2011 and 2010, respectively.



Note 9 – Stockholders' Equity



a) Statutory Reserve



As stipulated by the Company Law of the PRC
as applicable to PRC companies with foreign ownership, net income after taxation can only be distributed as dividends after appropriation
has been made for the following:



| | i. | making up cumulative prior years’ losses, if any;
| | -- | -------------------------------------------------



| | ii. | allocations to the “statutory surplus reserve” of at least 10% of income after tax, as determined under PRC accounting rules and regulations, until the fund amounts to 50% of the Company's registered capital; and
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | iii. | allocations to the discretionary surplus reserve, if approved in the shareholders’ general meeting.
| | ---- | ---------------------------------------------------------------------------------------------------



19







As of March 31, 2011 and December 31, 2010,
the remaining amount needed to fulfill the 50% registered capital requirement was approximately $65,021,505 and $65,408,874, respectively.



b) Stock-based Compensation



2009 Stock Option and Stock Award Plan



On March 11, 2009, the Board approved by written
consent the China Natural Gas, Inc. 2009 Employee Stock Option and Stock Award Plan (the “Plan”). Pursuant to the Plan,
there are currently 1,460,000 shares of common stock of the Company authorized for issuance and the Company has granted 638,000
stock options as of March 31, 2011, of which 138,000 have been exercised and 140,700 have been cancelled and are available for
reissuance. Thus, there are currently 962,700 shares of common stock of the Company available for future issuance under the
Plan and 359,300 options outstanding. The exercise price for all of the outstanding options is $4.90 per share.



Compensation expense of $160,897 and $52,838 was
recorded during the three months ended March 31, 2011 and 2010, respectively, relating to options granted under the Plan.



As of March 31, 2011, $1,287,177 of estimated
expense with respect to non-vested stock-based compensation has yet to be recognized and will be recognized in expense over the
optionee’s remaining weighted average service period of approximately two years.



There were no options granted, forfeited or
exercised during the three months ended March 31, 2011.



The following is a summary of the status of
stock options outstanding and exercisable as of March 31, 2011:



|Outstanding Options |      |  | Exercisable Options | 
|------------------- | ---- |  | ------------------- | 
|Exercise Price      |      |  | Number              | 
|$                   | 4.90 |  |                     | 



20







Note 10 – Earnings per Share



The following is a calculation of basic and diluted earnings per
common share:



|                                      |  | For the three months ended March 31, |           
|------------------------------------- |  | ------------------------------------ | ----------
|                                      |  | 2011                                 |           
|                                      |  |                                      |           
|Basic earnings per share              |  |                                      |           
|                                      |  |                                      |           
|Net income                            |  | $                                    | 2,485,831 
|                                      |  |                                      |           
|Weighted shares outstanding-Basic     |  |                                      | 21,321,904
|                                      |  |                                      |           
|Earnings per share-Basic              |  | $                                    | 0.12      
|                                      |  |                                      |           
|Diluted earnings per share            |  |                                      |           
|                                      |  |                                      |           
|Net income                            |  | $                                    | 2,485,831 
|                                      |  |                                      |           
|Weighted shares outstanding -Basic    |  |                                      | 21,321,904
|Effect of diluted securities-Warrants |  |                                      | -         
|Effect of diluted securities-Options  |  |                                      | 36,851    
|Weighted shares outstanding-Diluted   |  |                                      | 21,358,755
|                                      |  |                                      |           
|Earnings per share-Diluted            |  | $                                    | 0.12      



The Company had outstanding warrants of 1,833,654
as of March 31, 2011 and 2010.  For the three months ended March 31, 2010, the average stock price was greater than the exercise
prices of the 1,450,000 warrants which resulted in additional weighted average common stock equivalents of 411,134. 383,654 outstanding
warrants were excluded from the diluted earnings per share calculation as the exercise price is greater than the average stock
price during this period. For the three months ended March 31, 2011, all 1,833,654 outstanding warrants were excluded from the
diluted earnings per share calculation as the exercise price is greater than the average stock price during this period.



The Company had 359,300 outstanding employee
stock options as of March 31, 2011. For the three months ended March 31, 2011, the average stock price was greater than the exercise
price of the options, which resulted in additional weighted average common stock equivalents of 36,851.



Note 11 – Related Party Transactions



|a) | Other payable - related party
|-- | -----------------------------



On February 24, 2011, the Company borrowed
$763,500 from the JV for working capital purposes.  This payable is due on demand with no interest rate.



|b) | Short-term borrowing from related party
|-- | ---------------------------------------



On February 17, 2011 and March 28, 2011, the
Company borrowed a total of $1.32 million, from Mr. Hao Qu, an employee of XXNGC and a shareholder of the Company for working capital
purposes. The loans are due in one year and bear interest at 4.4075% per year, which is the annual USD lending rate applied by
the Bank of China. The principal and interest will be paid on the due dates.



|c) | The Wang loan
|-- | -------------



Demaoxing was formed in November 2007 by relatives of Mr. Qinan
Ji, the Company’s Chief Executive Officer and Chairman of the Company’s Board of Directors (the “Demaoxing Promoters”).
In January 2010, SXNGE, one of the Company’s major subsidiaries, extended a loan of US$9,858,240 to Ms. Taoxiang Wang, who
obtained a 40% ownership interest in Demaoxing on January 21, 2010.  Ms. Taoxiang Wang used her 40% ownership interest
in Demaoxing and its assets as collateral for the Wang Loan. On January 26, 2010, the Wang Loan funds were remitted by SXNGE to
an account of Demaoxing. Management of the Company believed that the Wang Loan was adequately secured by collateral. On January
21, 2010, the Demaoxing Promoters also transferred 30% of their ownership interests in Demaoxing to Shaanxi Rongxin Real Estate
Co., Ltd. (“Rongxin”). The Board of Directors has determined that the Demaoxing Promoters retained indirect beneficial
interests in Demaoxing after transferring their ownership interests and thus the Wang Loan was a related party transaction.



The Company’s Board of Directors was not notified of the extension
of the Wang Loan by the Company, and did not approve the Loans. Upon learning of the existence of the Wang Loan in April 2010,
the Board of Directors required that the Wang Loan be immediately repaid. In April 2010, Demaoxing repaid the principal of the
Wang Loan and made an interest payment of US$140,722, settling the Wang Loan in full.



21







Note 12 –Concentrations



Concentration of natural gas vendors:

|                                          |  | For the three months ended March 31, |   
|----------------------------------------- |  | ------------------------------------ | --
|                                          |  | 2011                                 |   
|                                          |  |                                      |   
|Numbers of natural gas vendors            |  |                                      | 4 
|                                          |  |                                      |   
|Percentage of total natural gas purchases |  |                                      | 89



As of March 31, 2011 and December 31, 2010,
the Company had $152,952 and $159,513, respectively,  payable to its major suppliers.



The Company maintains long-term natural gas
purchase agreements with two of its vendors, Huojia Hualong Petrochemical Co., Ltd. and Qinshui Lanyan Coal Bed Methane Co.,
Ltd (“Qinshui Lanyan”), as of March 31, 2011.   Contracts are renewed on an annual basis. The Company’s
management reports that it does not expect any issues or difficulty in renewing the supply contracts with these vendors going forward.



Note 13 – Commitments and Contingencies



Lease Commitments



The Company entered into a series of long-term
lease agreements with outside parties to lease land use rights for the Company’s CNG fueling stations located in the PRC.
The agreements have terms ranging from 10 to 30 years. The Company makes annual prepayments for most of these lease agreements.  The
Company also entered into five office leases in Xi’an, PRC, one office lease in Wuhan, PRC, one office lease in Yichang,
PRC, one office lease in Huangshi, PRC and one office lease in New York, New York, USA.  The minimum future payments
for leasing land use rights and offices are as follows:



|Year ending December 31, 2011 |  | $ | 1,287,327  | 
|----------------------------- |  | - | ---------- | 
|Year ending December 31, 2012 |  |   | 2,035,048  | 
|Year ending December 31, 2013 |  |   | 1,874,914  | 
|Year ending December 31, 2014 |  |   | 2,237,697  | 
|Year ending December 31, 2015 |  |   | 1,961,313  | 
|Thereafter                    |  |   | 32,688,037 | 
|Total                         |  | $ | 42,084,336 | 



For the three months ended March 31, 2011 and
2010, the land use right and office lease expenses were $348,788 and $430,628, respectively.



22







Property and Equipment Purchase Commitments



As of March 31, 2011, the Company has purchase
commitments totaling $8,297,015 for materials, supplies, services and property and equipment for constructing the LNG plant and
other construction projects.



Natural Gas Purchase Commitments



The Company has existing long-term natural
gas purchase agreements with its major suppliers.



There is no natural gas purchase commitment
with any other suppliers except Qinshui Lanyan.The Company continues to seek lower-cost sources of supply. According to the agreement
with Qinshui Lanyan, the daily volume of coal bed gas the Company should purchase from Qinshui Lanyan is approximately 200,000
cubic meters, which is favorable to the Company because the purchase price of coal bed gas from Qinshui Lanyan is usually lower
that of natural gas purchased from other suppliers.



Legal Proceedings



|a) | The Company and certain of its officers and directors have been named as defendants in a putative class action lawsuit alleging violations of the federal securities laws. That action, captionedVandevelde v. China Natural Gas, Inc. , et al., C.A. No. 10-728, was filed on August 26, 2010 in the United States District Court for the District of Delaware. The plaintiff inVandevelde asserts that the Company, Qinan Ji, Zhiqiang Wang, Donald Yang, David She, Carl Yeung and Lawrence Leighton violated Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder, when it failed to disclose and properly account for the Loan in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 and Quarterly Report on Form 10-Q for the quarter ended March 31, 2010. The complaint alleges that the Pledge to secure the Loan violated the Indenture for the Senior Notes and the warrant agreement relating to the warrants issued to Abax, giving the holder of those notes and warrants the right to declare a default under the Indenture. The complaint further alleges that, on August 20, 2010, the Company amended its Annual Report on Form 10-K for the year ended December 31, 2009 and Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 to disclose the Loan and restate its financial statements in light of the note and warrant holder’s right to declare a default under the Indenture, and that the announcement of this news caused the price of our stock to drop by twenty percent. The plaintiff seeks damages in an unspecified amount to recover the losses purportedly suffered by the putative class as a result of that decline. The complaint also asserts claims against the individual defendants as controlling persons of the Company for violations of Section 20(a) of the Securities Exchange Act of 1934.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



A second action, captionedBaranowski v.
China Natural Gas, Inc., et al., Case No. 10-6572, was filed on September 3, 2010 in the United States District Court for the
Southern District of New York. The plaintiff in that action, which was based on the same claims as those asserted by the plaintiff
inVandevelde and on substantially similar allegations, voluntarily dismissed the action without prejudice on November 23,
2010.



Two putative class members in theVandevelde
action have moved for appointment as lead plaintiff. After the Court decides those motions, the putative class member who
is appointed lead plaintiff will have an opportunity to file an amended complaint. The defendants will not be required to answer
or otherwise respond to the complaint until after the lead plaintiff either decides to proceed on the basis of the original complaint
or files an amended complaint.



The Company intends to defend this case vigorously.
The Company currently cannot estimate the outcome of this litigation as of the date of this report.



|b) | A former member of the board of directors filed a lawsuit on June 16, 2008 against the Company in New York State Supreme Court, Nassau County, in which he has sought, among other things, to recover a portion of his monthly compensation plus 20,000 options that he alleges are due to him pursuant to a written agreement. After the plaintiff rejected an offer by the Company that included the options that plaintiff alleged were due to him, the Company moved to dismiss the complaint. The judge ordered the Company to issue the 20,000 options to the plaintiff subject to any restrictions required by applicable securities laws, which was essentially what the Company had previously offered, and dismissed all of the plaintiff's remaining claims against the Company. The current board of directors has complied with the court's decision by tendering an option agreement to the plaintiff consistent with the court's decision, but the plaintiff has refused to execute the agreement, and instead has filed an appeal. On March 16, 2010, the Supreme Court of the State of New York denied the motion for leave to appeal. We believe the case will not have any material adverse effect on our financial condition or our results of operations.
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Note 14 – Subsequent Event



On April 21, 2011, 12 employees of the Company
exercised options for 136,750 shares of common stock at an exercise price of $4.90. Total proceeds of $670,075 were received by
the Company as a result of these transactions.



23











Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations



Special Note About Forward-Looking Statements



This Quarterly Report contains statements that are forward-looking
and, as such, are not historical facts. Rather, these statements constitute projections, forecasts and forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not guarantees of performance.
They involve known and unknown risks, uncertainties, assumptions and other factors which may cause the actual results, performance
or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied
by these statements. Such statements can be identified by the fact that they do not relate strictly to historical or current facts.
These statements use words such as “believe,” “expect,” “should,” “strive,” “plan,”
“intend,” “estimate,” “anticipate” or similar expressions. When the Company discusses its strategies
or plans, it is making projections, forecasts or forward-looking statements. Actual results and stockholders’ value will
be affected by a variety of risks and factors, including, without limitation, the recent crisis in worldwide financial markets,
international, national and local economic conditions, merger, acquisition and business combination risks, financing risks, geo-political
risks, and acts of terror or war. Many of the risks and factors that will determine these results and stockholder values are beyond
the Company’s ability to control or predict. These statements are necessarily based upon various assumptions involving judgment
with respect to the future. You should carefully read the risk factor disclosure contained in “Item 1A. Risk Factors”
of our Annual Report on Form 10-K for the year ended December 31, 2010, where many of the important factors currently
known to management that could cause actual results to differ materially from those in our forward-looking statements are discussed.



All such forward-looking statements speak only as of the date of
this Quarterly Report. The Company is under no obligation , nor does it intend to, release publicly any updates or revisions to
any forward-looking statements contained herein to reflect any change in the Company’s expectations with regard thereto or
any change in events, conditions or circumstances on which any such statement is based.



Overview



We are an integrated natural gas operator in The People’s
Republic of China (referred to as China or the PRC), primarily involved in distribution of compressed natural gas, or CNG, through
our fueling stations owned by our variable interest entity, or VIE, Xi’an Xilan Natural Gas Co., Ltd. (XXNGC). As of March
31, 2011, our VIE operated 26 CNG fueling stations in Shaanxi Province and 12 CNG fueling stations in Henan Province. Our VIE owns
the CNG fueling stations while we lease the land upon which our VIE-owned CNG fueling stations operate. For the three months ended
March 31, 2011, we sold 38,785,147 cubic meters of CNG through our fueling stations, compared to 40,592,457 cubic meters for the
three months ended March 31, 2010. The decrease in sales is consistent with the decrease in the average sales volume per CNG fueling
station. Our VIE also transports, distributes and sells piped natural gas to residential and commercial customers in the city of
Xi’an in Shaanxi Province, including Lantian County, and the districts of Lintong and Baqiao, and in the city of Lingbao
in Henan Province, through a high pressure pipeline network of approximately 120 kilometers.





24









We are pursuing multiple, synergistic paths of growth through our
VIE, XXNGC, and XXNGC’s subsidiaries, all of which are based in the PRC. We intend to:



| | ● | enter the liquefied natural gas, or LNG, business through the construction of an LNG production facility in Jingbian County, Shaanxi Province, and LNG fueling stations in Shaanxi and Hubei Provinces;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | ● | capitalize on the opportunities arising from the busy shipping activities on the Yangtze River by expanding into Hubei Province through the construction of LNG fueling stations located in harbors along the Yangtze River, inland LNG fueling stations and reserve LNG stations along the course of the Yangtze River, as well as continued development of conversion technologies and operations to modify river vessels to run on a mixture of LNG and diesel; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | ● | continue to grow our CNG business in Shaanxi and Henan Provinces by adding new CNG fueling stations to our network, and expanding our CNG business into Hubei Province.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



For additional information regarding these growth initiatives, please
see “Recent Developments” below.



Current Operations



We currently operate four main business lines:



| | ● | Distribution and sales of CNG through our VIE-owned CNG fueling stations serving hybrid (natural gas/gasoline) powered vehicles (38 stations in total as of March 31, 2011);
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | ● | Installation, distribution and sales of piped natural gas to residential and commercial customers through our VIE-owned pipelines. We distributed and sold piped natural gas to approximately 116,000 residential customers as of March 31, 2011, as compared to approximately 111,000 as of March 31, 2010
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | ● | Distribution and sales of gasoline through our VIE-owned CNG fueling stations for gasoline and hybrid (natural gas/gasoline) powered vehicles (five of our VIE owned CNG fueling stations sold gasoline as of March 31, 2011, as compared to eight as of March 31,2010); and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | ● | Conversion of gasoline-fueled vehicles to hybrid (natural gas/gasoline) powered vehicles at our automobile conversion workshops.
| | - | --------------------------------------------------------------------------------------------------------------------------------



We purchase all of the natural gas that we sell and distribute to
our customers from our suppliers. We are not involved in the mining or production of natural gas. We currently sell our natural
gas in two forms: (i) CNG and (ii) piped natural gas.



We had total revenues of $24,108,108 and $19,366,823 for the three
months ended March 31, 2011 and 2010, respectively. We had net income of $2,485,831 and $3,995,270 for the three months ended March
31, 2011 and 2010, respectively.



25







Recent Developments



LNG Business



As of March 31, 2011, we had invested $66.8 million in Phase I of
the LNG plant project located in Jingbian County, Shaanxi Province, which, when operational, will have a processing capacity of
500,000 cubic meters per day, or approximately 150 million cubic meters on an annual basis. We expect to invest approximately an
additional $1.75 million into Phase I of this plant, including $0.81 million of construction costs and $0.94 million of capitalized
interest, to complete test runs and satisfy the installment payments to contractors. We had commenced the test run of Phase I of
our LNG plant during 2010 and, in December 2010, we conducted and completed further test runs, including testing the operation
of various components and equipment of the plant. At present, the LNG plant is under preparation for production. The launch of
the operations of the plant will serve as a precursor to our backward and forward integration strategies, which involve the development
of our own network of LNG fueling stations in Shaanxi and Hubei Provinces.



The total expected cost of $68.5 million is higher than what
we originally anticipated. The increased costs were attributable to unforeseen cost overruns and escalations, including increase
in material and labor costs incurred to reinforce pilings based upon modified engineering analyses, as well as rising prices of
land use rights, which we believe resulted from recent energy resource exploration activities in nearby areas. Phase I construction
has also experienced delays due to changes in government policies with respect to tariff exemptions for core equipment imported
by us and related additional paperwork requirements of the customs agency of Shaanxi Province, and increased international shipment
times for ordered equipment due to the modification by international cargo carriers of traditional shipment routes to avoid pirates
along the Coast of Somalia, both of which prolonged the delivery time of the equipment we ordered from abroad.



In addition, as of March 31, 2011, we had invested $38.0 million
for the construction of Phases II and III of the LNG plant. We currently estimate that a further investment in Phases II and III
of $204.7 million through December 2015 would be needed to finance the construction of a processing capacity of 3,000,000 cubic
meters of LNG per day, or approximately 900 million cubic meters per year.



On September 2, 2010, we announced the completion of our first LNG
fueling station. The station is located in Hongqing District, Xi'an, and we believe it is the first LNG fueling station in Shaanxi
Province. The LNG fueling station will initially serve as a working model to showcase the market potential of LNG to future users
rather than to generate revenues.



Hubei Province and Yangtze River



In April 2010, we received the approval from local government authorities
in Hubei Province to build LNG fueling stations, both inland and in harbors, along the Yangtze River and reserve LNG stations.
In addition, during the third quarter of 2010, we completed the acquisition of Hanchun Makou Yuntong Compressed Natural Gas Co.,
Ltd., or Makou, for a purchase price of $3,648,080. Makou owns and operates a CNG compressor station in Hanchuan City, Hubei Province,
and purchases natural gas through pipelines, conducts compressing and sells natural gas on a wholesale basis through tankers to
fueling stations in Hubei Province. We believe that the Makou acquisition laid the foundation for expanding our CNG business
into Hubei Province. Makou’s compressor station currently has sufficient capacity to process 80,000 to 100,000 cubic meters
of natural gas daily and is advantageously located near railways and arterial highways.



26









We are also seeking to develop the market demand for natural gas
in the Yangtze River shipping industry by leveraging our automobile conversion know-how to develop conversion technologies and
operations to modify river vessels to be powered by a mixture of LNG and diesel. In August 2010, a tugboat modified by us to operate
on a mixture consisting of 70% LNG and 30% diesel completed its maiden voyage on the Yangtze River, which we believe was the first
time that an LNG-powered ship navigated China’s domestic waterways. As of March 31, 2011, we are in the process of developing
the market for our natural gas products along the Yangtze river.



Shaanxi and Henan Provinces



During the second quarter of 2010, XXNGC effectively acquired 100%
of the assets and operating rights of four CNG fueling stations in Xi’an, Shaanxi Province, for aggregate cash consideration
of $10,502,490. During the third quarter of 2010, we closed one CNG fueling station in Shaanxi Province because the local government
pulled down the district where the station was located for reconstruction. During the first quarter of 2011, we closed one CNG
fueling station in Shaanxi Province due to changes in market situation. As a result, as of March 31, 2011, XXNGC operated 26 CNG
fueling stations in Shaanxi Province and 12 CNG fueling stations in Henan Province. Four gasoline fueling stations were closed
in November and December 2010, due to changes in market situation in their respective local areas. During the first quarter of
2011, we reopened one of the closed gasoline fueling station. As of March 31, 2011, we operated five gasoline fueling stations.



Factors Affecting Our Results of Operations



Successful expansion of our CNG business.  Our
revenue increased by 24.5% during the three months ended March 31, 2011, compared to the three months ended March 31, 2010, largely
due to increased CNG sales driven by the addition of four new CNG fueling stations in Xi’an in the second quarter of 2010,
and larger piped natural gas revenue as a result of our acquisition of Makou in the third quarter of 2010. As of March 31, 2011,
we operated 38 CNG fueling stations in total, with 26 CNG fueling stations in Shaanxi Province alone. While we intend to expand
into different provinces, we anticipate the growth of our CNG fueling business in Xi’an and Henan Province will continue
to significantly affect our results of operations, as currently the majority of our CNG fueling stations are operating in these
regions, and we intend to continue to increase the number of CNG fueling stations we operate in these areas.



Regulation of natural gas prices in the PRC.  The
prices at which we purchase our natural gas supplies and sell CNG and pipeline natural gas products are strictly regulated by the
PRC central government, including the National Development and Reform Commission, or the NDRC, and the local pricing administrations
have the discretion to set natural gas prices within the price range set by the PRC central government. During the fourth quarter
of 2010, both the procurement and sales prices of our natural gas have increased in Shaanxi and Henan Provinces at different levels
based on regulatory changes implemented by the PRC government as well as local administration. Because the increase in
procurement prices in Henan Province was greater than that in sales prices, our gross margin declined in the first quarter of 2011.
In addition, natural gas procurement and sales prices are not uniform across China and can vary between provinces. For example,
the prices at which we procure and sell CNG and piped natural gas are usually lower in Shaanxi Province than in Henan Province.
Accordingly, our results of operations and, in particular, our revenue, cost of revenue and gross profit and gross margin are affected
significantly by factors which are outside of our control, as discussed above, including the regulation of gas products both on
the national and local levels. As we expand our natural gas business into other provinces, we expect our results of operations
to continue to be affected significantly by the regulations over natural gas prices in the PRC.





27









Government policies encouraging the adoption of cleaner burning
fuels.  Our results of operations for the periods covered by this report have benefited from environmental regulations
and programs in the PRC that promote the use of cleaner burning fuels, including natural gas, for vehicles. As an enterprise engaged
in the natural gas industry, our VIE, XXNGC, benefits from a reduced income tax rate of 15% compared to the standard 25% enterprise
income tax rate in the PRC. In addition, the PRC government has encouraged companies to invest in and build the necessary transportation,
distribution and sales infrastructure for natural gas in various policy pronouncements, such as by officially including CNG/gasoline
hybrid vehicles in the PRC’s “encouraged development” category. These policies have benefitted our results of
operations by encouraging the demand for our natural gas products and also by lowering our expenses. As we plan to expand into
the LNG business, we anticipate that our results of operations will continue to be affected by government policies encouraging
the adoption of cleaner burning fuels and the increased adoption of CNG and LNG technologies.



The overall economic growth of China.We
do not export our products and our results of operations are thus substantially affected by various economic factors, including
the growth of the natural gas industry in the PRC, the increase in domestic residential, commercial and vehicular consumption,
the overall growth of the Chinese economy and related developments. Although the PRC government has initiated extensive domestic
stimulus spending programs, expanded bank lending levels, increased the speed of regulatory approvals of new construction projects
and other economic policies, we are currently unable to predict the overall direction of the PRC economy. Our results of operations
will continue to be impacted by macro-economic trends both in China and globally.



Taxation



United States



We are incorporated in the State of Delaware and are subject to
the tax laws of the United States. We incurred a net operating loss for income tax purposes for the period ended March 31, 2011
and the estimated net operating loss carry-forwards for U.S income tax purposes amounted to $6,267,768 and $4,934,195 as of March
31, 2011 and December 31, 2010, respectively, which may be available to reduce future years' taxable income. These carry-forwards
will expire, if not utilized, beginning in 2027 through 2031. Our management believes that the realization of the benefits arising
from this loss appear to be uncertain due to our limited operating history and continuing losses for U.S. income tax purposes.
Accordingly, we have provided a 100% valuation allowance at March 31, 2011.



28









The PRC



Our subsidiary, VIE and its subsidiaries operate in China. Starting
January 1, 2008, pursuant to the tax laws of China, general enterprises are subject to income tax at an effective rate of 25%,
as compared to 33% prior to 2008. Based on certain income tax regulations adopted in 2001 to encourage the development of certain
industries, including the natural gas industry, in the western portions of China such as Shaanxi Province, XXNGC is subject to
a reduced tax rate of 15%. Accordingly, except for income from XXNGC, which is subject to the reduced tax rate of 15%, income from
Shaanxi Xilan Natural Gas Equipment Co., Ltd. (referred to as SXNGE, a wholly foreign owned enterprise), Jingbian Xilan LNG Co.,
Ltd (referred to as SJLNG, a wholly owned subsidiary of XXNGC), Xi’an Xilan Auto Body Shop Co., Ltd. (referred to as XXABC,
a wholly owned subsidiary of XXNGC), Henan Xilan Natural Gas Co., Ltd. (referred to as HXNGC, a wholly owned subsidiary of XXNGC),
Lingbao Yuxi Natural Gas Co., Ltd (referred to as Lingbao Yuxi, a wholly owned subsidiary of XXNGC) and Hubei Xilan Natural Gas
Co., Ltd. (referred to as HBXNGC, a wholly owned subsidiary of XXNGC ) are subject to the 25% PRC income tax rate. Our effective
income tax rate for the three months ended March 31, 2011 and 2010 were approximately 27.8% and 18.6%, respectively.



Value-added Tax. Sales revenue represents the invoiced
value of goods, net of a value-added tax, or VAT. The products of our VIE, XXNGC, and two of XXNGC’s subsidiaries, Lingbao
Yuxi and Makou, that are sold in the PRC are subject to a PRC VAT at a rate of 13% of the gross sales price. Under PRC tax laws,
the VAT may be offset by VAT paid by XXNGC or Lingbao Yuxi, as applicable, on purchased raw materials and other materials included
in the cost of producing their finished products. XXNGC recorded VAT payable and VAT receivable net of payments in our financial
statements. The VAT tax return is filed offsetting the payables against the receivables. When output tax of VAT is greater than
input tax of VAT, the tax difference will be paid to the national tax bureau for different government levels.



All revenues from XXNGC’s wholly owned subsidiary, XXABC,
are subject to a PRC VAT at a rate of 6%. This VAT cannot be offset with VAT paid for purchased materials included in the cost
of revenues.



RESULTS OF OPERATIONS



Three Months Ended March 31, 2011 Compared to Three Months Ended
March 31, 2010



Revenues



The following table sets forth a breakdown of our revenues for the
periods indicated:





|                                  |  | Three Months Ended |            |  | Increase       |   |            | Increase                    | 
|--------------------------------- |  | ------------------ | ---------- |  | -------------- | - | ---------- | --------------------------- | 
|                                  |  | March 31, 2011     |            |  | March 31, 2010 |   |            | (decrease) in dollar amount | 
|Natural gas from fueling stations |  | $                  | 18,256,422 |  |                | $ | 14,629,610 |                             | 
|                                  |  |                    |            |  |                |   |            |                             | 
|Natural gas from pipelines        |  |                    | 2,091,407  |  |                |   | 854,019    |                             | 
|                                  |  |                    |            |  |                |   |            |                             | 
|Gasoline                          |  |                    | 1,307,174  |  |                |   | 1,468,816  |                             | 
|                                  |  |                    |            |  |                |   |            |                             | 
|Installation                      |  |                    | 2,011,694  |  |                |   | 2,007,774  |                             | 
|                                  |  |                    |            |  |                |   |            |                             | 
|Automobile conversion             |  |                    | 441,411    |  |                |   | 406,604    |                             | 
|                                  |  |                    |            |  |                |   |            |                             | 
|                                  |  | $                  | 24,108,108 |  |                | $ | 19,366,823 |                             | 







29









Revenues . Revenues for the three months ended March
31, 2011 increased to $24,108,108 from $19,366,823 for the three months ended March 31, 2010, an increase of $4,741,285 or 24.5%.
We sold natural gas of 45,906,401 cubic meters during the three months ended March 31, 2011, compared to 44,161,281 cubic meters
during the three months ended March 31, 2010. We also sold gasoline of 1,495,015 liters during the three months ended March 31,
2011, compared to 1,929,034 liters sold during the three months ended March 31, 2010. For the three months ended March 31, 2011,
89.8% of our revenues was generated from the sale of natural gas and gasoline, and the remaining 10.2 % was generated from our
installation and auto conversion services.



Natural Gas from Fueling Stations. Natural gas revenue
from our fueling stations increased by 24.8% or $3,626,812, to $18,256,422 for the three months ended March 31, 2011, from $14,629,610 for
the three months ended March 31, 2010. Natural gas revenue from our fueling stations accounted for 75.7% of our total revenues
for the three months ended March 31, 2011, which was the largest contributor among our major business lines. During the three months
ended March 31, 2011, we sold 38,785,147 cubic meters of compressed natural gas, or CNG, compared to 40,592,457 cubic meters during
the three months ended March 31, 2010, through our fueling stations. Though sales volume decreased over the period, sales revenue
actually increased, because the average unit selling price increased to $0.48 (RMB 3.13) from $0.34 (RMB 2.34), net of VAT, due
to increased competition from a growing number of natural gas fueling stations in the regions we operate. With respect to
average sales revenue and volume per station, in the three months ended March 31, 2011, we sold approximately $480,432 and
1,020,662 cubic meters of CNG per station, respectively, compared to approximately $406,378 and 1,127,568 cubic meters, respectively,
in the three months ended March 31, 2010.



Natural Gas from Pipelines.  Natural gas revenue
from our pipelines increased by 144.9%, or $1,237,388, to $2,091,407 for the three months ended March 31, 2011, compared to $854,019
for the three months ended March 31, 2010, and contributed 8.7% of our total revenues for the three months ended March 31, 2011.
As of March 31, 2011, the Company had 115,787 pipeline customers, an increase of 5,074 from 110,713 at March 31, 2010. We
sold 7,121,254 cubic meters of natural gas through our pipelines for the three months ended March 31, 2011, compared to 3,285,286
cubic meters for the three months ended March 31, 2010, an increase of 116.8%, which was the primary factor contributing to the
growth in our revenue in the three months ended March 31, 2011.



Gasoline . Revenue from gasoline sales decreased by
11.0 %, or $161,642, to $1,307,174 for the three months ended March 31, 2011, compared to $1,468,816 for the three months ended
March 31, 2010, and contributed 5.4% of our total revenues for the three months ended March 31, 2011. The decrease was primarily
attributable to our closing four of our eight gasoline fueling stations during the fourth quarter of 2010.



30









Installation Services. Revenue from installation services
increased by 0.2%, or $3,920, to $2,011,694 for the three months ended March 31, 2011, compared to $ 2,007,774 for the three months
ended March 31, 2010, and contributed 8.3% of our total revenues for the three months ended March 31, 2011. Revenue from our four
largest customers accounted for 28.7%, 24.7%, 12.7% and 11.3%, respectively, of our installation revenue for the three months ended
March 31, 2011.



Auto Conversion Services. Revenue from our auto conversion
services increased by 8.6%, or $34,807, to $441,411 for the three months ended March 31, 2011, compared to $406,604 for the three
months ended March 31, 2010, and contributed 1.8% of our total revenue s for the three months ended March 31, 2011.



Cost of Revenue



The following table sets forth a breakdown of our costs of revenue
for the periods indicated:





|                                  |  | Three Months Ended |            |  | Increase / (decrease) in |   |            | Increase /    | 
|--------------------------------- |  | ------------------ | ---------- |  | ------------------------ | - | ---------- | ------------- | 
|                                  |  | March 31, 2011     |            |  | March 31, 2010           |   |            | dollar amount | 
|Natural gas from fueling stations |  | $                  | 10,482,954 |  |                          | $ | 7,272,136  |               | 
|                                  |  |                    |            |  |                          |   |            |               | 
|Natural gas from pipelines        |  |                    | 1,616,497  |  |                          |   | 592,518    |               | 
|                                  |  |                    |            |  |                          |   |            |               | 
|Gasoline                          |  |                    | 1,224,724  |  |                          |   | 1,367,278  |               | 
|                                  |  |                    |            |  |                          |   |            |               | 
|Installation                      |  |                    | 788,364    |  |                          |   | 798,054    |               | 
|                                  |  |                    |            |  |                          |   |            |               | 
|Automobile conversion             |  |                    | 275,268    |  |                          |   | 241,869    |               | 
|                                  |  |                    |            |  |                          |   |            |               | 
|                                  |  | $                  | 14,387,807 |  |                          | $ | 10,271,855 |               | 





Cost of revenue. Our costs of revenue consist of the
cost of natural gas and gasoline sold, installation and other costs. Costs of natural gas and gasoline sold consist of the costs
of purchases from our suppliers. Costs of installation and others include the expenditures that were incurred to connect customers
to our pipeline system, and the cost for converting gasoline-fueled vehicles into natural gas-fueled hybrid vehicles.



Our cost of revenue for the three months ended March 31, 2011 was
$14,387,307, an increase of $4,115,952, or 40.1%, compared to $10,271,855 for the three months ended March 31, 2010, mainly attributable
to increase in average procurement costs. Our average procurement price of natural gas increased to $0.37 (RMB 2.43) for the three
months ended March 31, 2011 from $0.25 (RMB 1.71) for the comparable period in 2010. Over the same period, our total revenues increased
by 24.5%.



31







Natural Gas from Fueling Stations. Costs of revenue
of our natural gas sold through our fueling stations increased by 44.2%, or $3,210,818, to $10,482,954 for the three months ended
March 31, 2011, from $7,272,136 for the three months ended March 31, 2010. The increase was primarily due to the increase in average
procurement prices from $0.25 (RMB 1.71), net of VAT, for the three months ended March 31, 2010, to $0.37 (RMB 2.43), net of VAT,
for the three months ended March 31, 2011. However, the average procurement cost remained below the natural gas average retail
price of $0.48 (RMB 3.13), net of VAT, for the three months ended March 31, 2010 and 2011, respectively.



Natural Gas from Pipelines. Costs of revenue for natural
gas sold through our pipelines increased by 172.8%, or $1,023,979, to $1,616,497 for the three months ended March 31, 2011, compared
to $592,518 for the three months ended March 31, 2010. The increase was basically consistent with growth in sales revenue.



Gasoline. Costs of our gasoline revenue decreased
by 10.4%, to $1,224,724 for the three months ended March 31, 2011, compared to $1,367,278 for the three months ended March 31,
2010. The decrease was primarily due to our closure of four of our eight gasoline fueling stations in the fourth quarter of 2010.



Installation Services. Costs of revenue from our installation
services decreased by 1.2%, or $9,690, to $788,364 for the three months ended March 31, 2011, compared to $798,054 for the three
months ended March 31, 2010, primarily as a result of the increase in our pipeline customers.



Auto Conversion Services. Costs of our auto conversion
revenue increased by 13.8%, or $33,399, to $ 275,268 for the three months ended March 31, 2011, compared to $241,869 for the three
months ended March 31, 2010.



Gross Profit



The following table sets forth a breakdown of our gross profit for
the periods indicated:



|                                  |  | Three Months Ended |           |  | Increase       |   |           | Increase (decrease)         | 
|--------------------------------- |  | ------------------ | --------- |  | -------------- | - | --------- | --------------------------- | 
|                                  |  | March 31, 2011     |           |  | March 31, 2010 |   |           | (decrease) in dollar amount | 
|Natural gas from fueling stations |  | $                  | 7,773,468 |  |                | $ | 7,357,474 |                             | 
|                                  |  |                    |           |  |                |   |           |                             | 
|Natural gas from pipelines        |  |                    | 474,910   |  |                |   | 261,501   |                             | 
|                                  |  |                    |           |  |                |   |           |                             | 
|Gasoline                          |  |                    | 82,450    |  |                |   | 101,538   |                             | 
|                                  |  |                    |           |  |                |   |           |                             | 
|Installation                      |  |                    | 1,223,330 |  |                |   | 1,209,720 |                             | 
|                                  |  |                    |           |  |                |   |           |                             | 
|Automobile conversion             |  |                    | 166,142   |  |                |   | 164,735   |                             | 
|                                  |  |                    |           |  |                |   |           |                             | 
|                                  |  | $                  | 9,720,301 |  |                | $ | 9,094,968 |                             | 





32







We earned a gross profit of $9,720,301 for the three months ended
March 31, 2011, an increase of $625,333, or 6.9%, compared to $9,094,968 for the three months ended March 31, 2010. The increase
in gross profit was primarily contributed by the increase in sales revenues, though our gross profit margin decreased.



Gross margin



Gross margin for natural gas sold through our fueling stations decreased
from 50.3% for the three months ended March 31, 2010 to 42.6% for the three months ended March 31, 2011, from 50.3% for the
three months ended March 31, 2010, primarily because our average purchasing costs of natural gas had increased at a greater
rate than sales prices.



Gross margin for natural gas sold through pipelines decreased from
30.6 % for the three months ended March 31, 2010, primarily because our average purchasing costs of natural gas had increased at
a greater rate than sales prices.



Gross margin for gasoline sales decreased slightly to 6.3% for the
three months ended March 31, 2011, compared to 6.9% for the three months ended March 31, 2010.



Gross margin for our installation business increased slightly to
60.8% for the three months ended March 31, 2011 from 60.3% for the three months ended March 31, 2010.



Gross margin for our auto conversion business decreased to
37.6% for the three months ended March 31, 2011, compared to 40.5% for the three months ended March 31, 2010, due to intensified
competition in the market.



Since the growth rate of sales revenue was lower than that
of costs of revenue, primarily due to the material increase in average purchasing costs of natural gas and our decreased sales
volume of natural gas, our total gross margin decreased to 40.3 % for the three months ended March 31, 2011 from 47.0% for the
three months ended March 31, 2010.



Operating expenses



We incurred operating expenses of $6,490,892 for the three months
ended March 31, 2011, an increase of $1,781,446 or 37.8%, from $4,709,446 for the three months ended March 31, 2010.



Selling expenses increased by $688,131, or 23.8%, to $3,579,921
for the three months ended March 31, 2011, from $2,891,790 for the three months ended March 31, 2010, primarily due to the increase
of $297,431 in salaries and $331,815 in depreciation.



General and administrative expenses increased by $1,093,315, or
60.1%, to $2,910,971 for the three months ended March 31, 2011, primarily attributable to the increase of $108,508 in non-cash
expense of stock options granted to employees according to our employee stock option plan, $787,949 in legal fees, $313,999 in
consulting fees, as well as increased Delaware franchise tax due to our increased outstanding share and asset base. An analysis
by region or entity demonstrates that the general and administrative expenses for our operations in Hubei and Shaanxi Provinces,
and the management expenses of SJLNG, a wholly owned subsidiary of XXNGC, increased, primarily due to the rapid growth and expansion
of these entities.



33







Income from Operations and Operating Margin



Income from operations decreased by $1,156,112, or 26.4%, to $3,229,410
for the three months ended March 31, 2011, from $4,385,522 for the three months ended March 31, 2010, primarily attributable to
the increase in procurement costs and operating expenses. Our operating margin for the three months ended March 31, 2011 was 13.4%,
compared to 22.6% for the three months ended March 31, 2010.



Non-Operating Income (Expense)



Non-operating income was $212,074 for the three months ended March
31, 2011, compared to $520,893 for the three months ended March 31, 2010, primarily due to the change in fair value of our outstanding
warrants that decreased to $116,180 for the three months ended March 31, 2011 from $393,068 for the three months ended March 31,
2010.



Provision for Income Tax



Income tax was $955,653 for the three months ended March 31, 2011,
compared to $911,145 for the three months ended March 31, 2010. Although the change in the amount of income tax expense was not
material, the effective income tax rate rose from 18.6% to 27.8% in this period. The increase was primarily attributable to certain
entities in a start-up, non-operational stage (such as SJLNG and HBXNGC) that were not generating any revenue or profit in the
first quarter of 2011, but incurring a considerable amount of selling expenses and general and administrative expenses for this
period, materially reducing the amount of income before tax, which is the denominator in the calculation of effective income tax
rate. As a result, effective income tax rate rose materially.



Net Income



Net income decreased by $1,509,439, or 37.8%, to $2,485,831 for
the three months ended March 31, 2011, compared to $3,995,270 for the three months ended March 31, 2010 based on the various factors
discussed above. Net margin decreased to 10.3% for the three months ended March 31, 2011, compared to 20.6% for the three months
ended March 31, 2010, primarily due to increased purchasing costs of natural gas at a higher rate compared to our sales prices
and the increased operating expenses.



LIQUIDITY AND CAPITAL RESOURCES



Historically, our primary sources of liquidity consisted of cash
generated from our operations, debt financing and proceeds from equity offerings. In 2008, we sold senior notes with a face value
of $40 million to Abax Lotus Ltd. In September 2009, we completed a secondary offering of common stock with gross proceeds of approximately
$57 million. Our principal uses of cash have been, and are expected to continue to be, working capital for operational purposes,
as well as for satisfying capital investment, such as constructing our LNG plant in Jingbian County, Shaanxi Province and other
projects.



34







As of March 31, 2011, we had $8,931,164 of cash and cash equivalents
on hand, compared to $10,046,249 of cash and cash equivalents as of December 31, 2010. The decrease was primarily attributable
to the construction of the LNG plant, additions of fueling stations and market development initiatives.



Net cash provided by operating activities was $2,457,583 for the
three months ended March 31, 2011, compared to $4,848,146 for the three months ended March 31, 2010. The decrease was primarily
due to the correlating decrease in net income, the increase in accounts receivables, higher balance of inventories, the increase
in other assets and the reduction in unearned revenue (customer prepayments).



Net cash used in investing activities decreased from $22,812,134
for the three months ended March 31, 2010 to $5,709,217 for the comparable period in 2011. The decrease was primarily due to an
absence of loans being made to outside parties in the three months ended March 31, 2011, in addition to investments in construction
in progress for the SJLNG LNG project being greatly reduced, as the investments for phase I of this project had been mostly completed
by the end of 2010, and because no loan was made by the Company to others in the three months ended March 31, 2011. The Company
loaned $9,858,171 to a related party, or the Wang Loan, and $4,400,969 to a non-related party at an annual rate of 5.84%, or the
Juntai Loan, during the first quarter of 2010.



Net cash from financing activities was $2,081,000 for the three
months ended March 31, 2011, due to the short-term loans borrowed from a senior management member, who is also a shareholder
of the Company and from our joint venture company, Henan CNPC Kunlun Xilan Compressed Natural Gas Co., Ltd..



Based on past performance and current expectations, we believe our
cash and cash equivalents, cash generated from operations, as well as future possible cash from financing activities, will satisfy
our working capital needs, capital expenditures and other liquidity requirements associated with our operations.



The majority of our revenues and expenses were denominated primarily
in RMB, the currency of the PRC. There is no assurance that exchange rates between the RMB and the USD will remain stable. Inflation
has not had a material impact on our business.



OFF-BALANCE SHEET ARRANGEMENTS



We do not have any off-balance sheet arrangements that have or are
reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses,
results of operations, liquidity, capital expenditures or capital resources that are material to our investors.



CAPITAL EXPENDITURES



Our planned capital expenditures as of March 31, 2011 were approximately
$222.7 million through December 2015, the majority of which are expected to be incurred in connection with Phases II and III of
the LNG plant in Jingbian County, Shaanxi Province, construction or acquisition of additional fueling stations and compressor stations,
and funding for the expansion of our operations in Hubei Province. We expect to fund the capital expenditures through cash flows
from operations as well as through potential equity and debt offerings.



Outstanding Indebtedness



On December 30, 2007, we entered into a securities purchase agreement
with Abax Lotus Ltd. (“Abax”) and, on January 29, 2008, we entered into an amendment to such agreement with Abax (the
“Purchase Agreement”, as amended). Under the Purchase Agreement, on January 29, 2008, we sold to Abax $20,000,000 in
principal amount of our 5.0% Guaranteed Senior Notes due 2014 (the “Senior Notes”) and warrants to purchase 1,450,000
shares of our common stock and, on March 3, 2008, we issued to Abax an additional $20,000,000 in principal amount of Senior Notes.



35







We are required to make mandatory prepayments on the Senior Notes
on certain dates and we are subject to customary covenants for financings of this type, including restrictions on the incurrence
of liens, payment of dividends and disposition of properties as well as being obligated to maintain certain financial ratios.



Long-Term Loan



On February 26, 2010, JBLNG entered into a fixed assets loan contract
with Shanghai Pudong Development Bank Xi’an Branch (“SPDB”), pursuant to which the SPDB agreed to lend $17,964,000
to JBLNG. SPDB transferred $13,473,000 and $4,491,000 to JBLNG on March 17 and May 28, 2010, respectively. The applicable interest
rate of this loan is the standard three- to five-year rate issued by the People’s Bank of China’s, 5.76% for the
first year and subject to adjustment commencing from the second year. As the People’s Bank of China adjusted the standard
interest rate twice in October and December 2010, respectively, since January 1, 2011, the interest rate of these loans has been
adjusted to 6.22%. As the People’s Bank of China adjusted the standard interest rate twice in February and April, 2011, beginning
January 1, 2012 the interest rate of these loans will be 6.65%. The loan period is 58 months from the date of effectiveness of
the contract, and will be repaid annually, with the last repayment to be no later than December 5, 2014. The loan is guaranteed
by XXNGC and secured by XXNGC’s equipment and vehicles located within the PRC.



Contractual Obligations



Our contractual obligations are as follows:



|                                                           |  | Payments due by period |        
|---------------------------------------------------------- |  | ---------------------- | -------
|                                                           |  |                        |        
|Contractual obligations                                    |  | Total                  |        
|                                                           |  |                        |        
|Long-term debt obligations                                 |  | $                      | 40,000 
|Capital lease obligations                                  |  |                        | -      
|Operating lease obligations(1)                             |  |                        | 42,084 
|Purchase obligations (2)                                   |  |                        | 8,297  
|Other long-term liabilities reflected on balance sheet (3) |  |                        | 17,500 
|Long-term loan                                             |  |                        | 18,324 
|                                                           |  |                        |        
|Total                                                      |  | $                      | 126,205



(1) We entered into a series of long-term lease agreements with
outside parties to lease land use rights for the self-built natural gas fueling stations located in the PRC. The agreements have
terms ranging from 10 to 30 years. We make annual prepayments for most lease agreements. We also entered into two office leases
in Xi’an, the PRC, one office lease in Jingbian County, Shaanxi Province, one office lease in Wuhan, Hubei Province, and
one office lease in New York, United States of America (“USA”).



(2) We have purchase commitments for materials, supplies, services
and property and equipment for constructing the LNG plant and other CIP projects.



(3) The $17,500,000 reflects derivative liability related to the
embedded put option in the 1,450,000 warrants we issued to Abax in January 2008. Abax is entitled to require us to purchase back
the portion of warrants not exercised upon expiration.



36







Natural Gas Purchase Commitments



We have existing long-term natural gas purchase agreements with
our major suppliers. However, none of those agreements stipulate any specific purchase amount or quota each year, thus giving the
Company sufficient flexibility to constantly look for lower-cost sources of supply. Therefore, the Company is not legally bound
in purchase commitments by those agreements.



We maintain long-term natural gas purchase
agreements with two of our vendors, Huojia Hualong Petrochemical Co., Ltd. and Qinshui Lanyan Coal Bed Methane Co., Ltd,,
as of March 31, 2011. Contracts are renewed on an annual basis. We do not expect any issues or difficulties in continuing to renew
our supply contracts with these vendors going forward. There is no natural gas purchase commitment with all other suppliers except
with Qinshui Lanyan, hence the Company has enough flexibility to constantly look for lower-cost sources of supply. According to
the agreement with Qinshui Lanyan, the daily volume of coal bed gas the Company should purchase from Qinshui Lanyan is approximately
200,000 cubic meters. Prices of natural gas are strictly controlled by the PRC government.



The sales prices of both pipeline natural gas in Shaanxi Province
and vehicular fuel in the city of Xi’an were raised on October 20, 2010. The sales price of pipeline natural gas in Shaanxi
Province increased by RMB 0.23 ($0.03) per cubic meter for residential use. The sales prices for commercial and industrial use
was increased by RMB 0.35 and RMB 0.55 ($0.05 and $0.08) per cubic meter, respectively. Additionally, the sales price of CNG for
vehicular fuel in Xi’an was adjusted based on the target ratio of 0.6:1 to the retail price of Grade 90 gasoline. The retail
price of CNG increased by RMB 0.9 ($0.14) per cubic meter. The adjusted prices took effect on October 20, 2010.



The sales prices of vehicular fuel in the cities of Kaifeng and
Xuchang, Henan Province were raised on July 20, 2010 and August 1, 2010, respectively. The sales price of vehicular fuel in Kaifeng
increased from RMB 3.30 ($0.42) to RMB 3.60 ($0.46) per cubic meter. The sales price of vehicular fuel in Xuchang increased from
RMB 3.20 ($0.41) to RMB 3.65 ($0.47) per cubic meter. Additionally, the sale prices of CNG for vehicular fuel in Kaifeng was adjusted
based on the target ratio of no less than 0.6:1 to the retail price of Grade 90 gasoline. The sale prices of CNG for vehicular
fuel in Xuchang was adjusted to no less than 0.6:1 to the retail price of Grade 90 gasoline and gradually to the target ratio of
no less than 0.75:1.



Foreign Currency Translations



Our reporting currency is the U.S. dollar (“USD”). The
functional currency of XXNGC and our and XXNGC’s PRC subsidiaries and, therefore, the functional currency of the Company,
is the RMB. The results of operations and financial position of XXNGC and our and XXNGC’s PRC subsidiaries are translated
to USD using the period end exchange rates as to assets and liabilities and weighted average exchange rates as to revenues, expenses
and cash flows. Capital accounts are translated at their historical exchange rates when the capital transaction occurred. The resulting
currency translation adjustments are recorded as a component of accumulated other comprehensive income (loss) within stockholders’
equity.



The balance sheet amounts, with the exception of equity, were translated
at the March 31, 2011 exchange rate of RMB 6.55 to $1.00 as compared to RMB 6.82 to $1.00 at March 31, 2010. The equity accounts
were stated at their historical rate. The average translation rates applied to income and cash flows statement amounts for the
three months ended March 31, 2011 and 2010 were RMB6.57 and RMB6.82 to $1.00, respectively.



37







Critical Accounting Policies



Our discussion and analysis of our financial position and results
of operations contained in this Form 10-Q is based on our condensed consolidated financial statements, contained elsewhere herein.
The preparation of these financial statements in conformity with generally accepted accounting principles requires that we make
estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates. There have been no material changes in the development of our accounting estimates or the assumptions
underlying those estimates, or the accounting policies that we disclosed as our Critical Accounting Policies in our Annual Report
on Form 10-K for the year ended December 31, 2010.



Construction in Progress



Construction in progress consists of the cost of constructing property
and equipment for CNG fueling stations and liquefied natural gas, or LNG, project in Jingbian County, Shaanxi Province, PRC, a
natural gas infrastructure project in the Xi’an International Port District and other projects, including technology licensing
fees, equipment purchases, land use rights requisition cost, capitalized interest and other construction fees. No depreciation
is provided for construction in progress until such time as the assets are completed and placed into service. Interest incurred
during construction is capitalized into construction in progress. All other interest is expensed as incurred.



Revenue Recognition



Revenue is recognized when services are rendered to customers and
when a formal arrangement exists, the price is fixed or determinable, the delivery is completed, no other significant obligations
of ours exist and collectability is reasonably assured. Payments received before all of the relevant criteria for revenue recognition
are satisfied are recorded as unearned revenue. Revenue from gas and gasoline sales is recognized when gas and gasoline is pumped
through pipelines to the end users. Revenue from installation of pipelines is recorded when the contract is completed and accepted
by the customers. Construction contracts are usually completed within one to two months. Revenue from repairing and modifying vehicles
is recorded when services are rendered to and accepted by the customers.



Fair Value of Financial Instruments



The accounting standards regarding fair value of financial instruments
and related fair value measurements define fair value, establish a three-level valuation hierarchy for disclosures of fair value
measurement, and provide disclosure requirements for fair value measures. The carrying amounts reported in the consolidated balance
sheets for current receivables and payables qualify as financial instruments. Management concluded the carrying values are a reasonable
estimate of fair value because of the short period of time between the origination of such instruments and their expected realization
and, if applicable, their stated interest rate approximates current rates available. The three levels are defined as follows:



38







| | ● | Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
| | - | ---------------------------------------------------------------------------------------------------------------------------------



| | ● | Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | ● | Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.
| | - | -----------------------------------------------------------------------------------------------------------



Financial assets and liabilities are classified in their entirety
based on the lowest level of input that is significant to the fair value measurement. Depending on the product and the terms of
the transaction, the fair value of our notes payable and derivative liabilities were modeled using a series of techniques, including
closed-form analytic formula, such as the Black-Scholes option-pricing model, which does not entail material subjectivity because
the methodology employed does not necessitate significant judgment, and the pricing inputs are observed from actively quoted markets.



A contract that would otherwise meet the definition of a derivative
but is both (a) indexed to the company’s own stock and (b) classified in stockholders’ equity in the balance sheet
would not be considered a derivative financial instrument.  There is a two-step model to be applied in determining whether
a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for the exception.
Changes in the fair value of warrants are recognized in the income statement.



Income Taxes



Deferred tax assets and liabilities are recognized for the expected
future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred
income taxes are recognized for the tax consequences in future years of temporary differences between the tax bases of assets and
liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable
to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary,
to reduce deferred tax assets to the amount expected to be realized. As at December 31, 2010 and 2009, there were no significant
book to tax differences except for warrants liability and stock based compensation. An uncertain tax position is recognized as
a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with
a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50%
likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit
is recorded. Penalties and interest incurred related to underpayment of income tax are classified as income tax expense in the
year incurred. No significant penalties or interest relating to income taxes have been incurred during the years ended December
31, 2010 and 2009.



39







Long-Lived Assets



We evaluate the carrying value of long-lived assets to be held and
used whenever events or changes in circumstances indicate that the assets might be impaired. Impairment losses are recorded
on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to
be generated by those assets are less than the assets' carrying amounts.  In that event, a loss is recognized based on
the amount by which the carrying amount exceeds the fair market value of the long-lived assets.  Loss on long-lived assets
to be disposed of is determined in a similar manner, except that fair market values are reduced for the cost of disposal.



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK



Natural Gas Price Risk



Our major market risk exposure continues to be the pricing applicable
to our purchases and value-added reselling of CNG. Our revenues and profitability depend substantially upon the applicable prices
of natural gas, which in China are regulated and fixed by the central and local governments and do not fluctuate significantly.
Such price stability is expected to continue for operations in China. We currently do not have any hedge positions in place to
reduce our exposure to changes in natural gas wholesale and retail prices.



Interest Rate Risk



We are subject to interest rate risk on our long-term fixed-interest
rate debt. Fixed rate debt, where the interest rate is fixed over the life of the instrument, exposes us to changes in market interest
rates reflected in the fair value of the debt and to the risk that we may need to refinance maturing debt with new debt at a higher
rate. All other things being equal, the fair value of our fixed rate debt will increase or decrease as interest rates change. We
had long-term debt outstanding of $53,743,000 at March 31, 2011, all of which bears interest at fixed rates. The fixed-rate debt
amount of $40,000,000 is due in 2014. The remaining portion of the outstanding long-term debt, in the amount of $13,743,000, bears
interest at floating rates, and is due between 2012 and 2014. We currently have no interest rate hedge positions in place to reduce
our exposure to changes in interest rates.



Foreign Currency Exchange Rate Risk



We operate using China’s local currency and the effects of
foreign currency fluctuations are largely mitigated because local expenses in China are also denominated in the same currency.



Our assets and liabilities, of which the functional currency is
the RMB, are translated into USD using the exchange rates in effect at the balance sheet date, resulting in translation adjustments
that are reflected as cumulative translation adjustment in the stockholders’ equity section on our consolidated balance sheets.
A portion of our net assets are impacted by changes in foreign currencies translation rates in relation to the U.S. dollar. We
recorded a $1,448,655 foreign currency translation gains to increase our equity account for the three months ended March 31, 2011,
to reflect the net impact of the fluctuation of RMB against USD.



Legal Proceedings Risk



The Company and certain of its officers and directors have been
named as defendants in a putative class action lawsuit alleging violations of the federal securities laws. Two actions regarding
the lawsuit have been filed on August 26, 2010 and September 3, 2010, respectively. The Company intends to defend this case vigorously.
The Company currently cannot estimate the outcome of this litigation as of the date of this report.



On March 16, 2010, regarding the lawsuit filed by a former member
of the board of directors on June 16, 2008 (as previously described in Part I, Item 3 (Legal Proceedings) of the 2010 Annual Report),
the Supreme Court of the State of New York denied the plaintif’s motion for leave to appeal.  We believe the case
will not have any material adverse effect on our financial condition or our results of operations. Other than this legal development,
there have been no material changes from the legal proceedings disclosed in Part I, Item 3 (Legal Proceedings) contained in the
2010 Annual Report.



40







ITEM 4 CONTROLS AND PROCEDURES



Disclosure Controls and Procedures



During and subsequent to the reporting period covered by this report,
and under the supervision and with the participation of our management, including our principal executive officer and our principal
financial officer, we conducted an evaluation of our disclosure controls and procedures that were in effect at the end of the period
covered by this report. Disclosure controls and procedures are defined under Rule 13a-15(e) of the Securities Exchange Act of 1934,
as amended (the “Exchange Act”), as those controls and other procedures of an issuer that are designed to ensure that
information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.  Disclosure
controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be
disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer'smanagement,
including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding
required disclosure.



During management’s evaluation of the effectiveness of internal
control over financial reporting in connection with this quarterly report for the quarter ended March 31, 2011, management concluded
that the Company continues to have the following material weakness in its internal control over financial reporting for
the quarter ended March 31, 2011:



|l | The Company does not maintain personnel with a sufficient level of accounting knowledge, experience and training in the application of the accounting principles generally accepted in the United States of America (“U.S. GAAP”) and SEC requirements in the application thereof.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|l | The Company entered into a related party transaction without appropriate authorization and failed to correctly disclose the Wang Loan as a related party transaction
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



|l | The Company failed to communicate to the Board of Directors of the Wang Loan and the Juntai Loan and entered into the Loans without approval of the Board of Directors
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



Based on their evaluation (and considering the material weaknesses
previously identified and discussed in our internal control over financial reporting, Item 9A, Controls and Procedures, in our
Annual Report on Form 10-K for the year ended December 31, 2010), our principal executive officer and principal financial officer
have concluded that our disclosure controls and procedures at March 31, 2011 were not effective.



Management’s Remediation Initiatives



In response to the above identified material weakness and to strengthen
our internal control over financial reporting, we have taken the following remediation initiatives:



|1) | Developing of a comprehensive training and development plan for our accounting personnel, including our Chief Financial Officer, Financial Controller and others, in the knowledge of the principles and rules of U.S. GAAP and the SEC requirements in the application thereof.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



41







|2) | Replacement of Mr. Qinan Ji as Chief Executive Officer of the Company. The Company is currently seeking to recruit a suitable CEO;
|-- | ----------------------------------------------------------------------------------------------------------------------------------



|3) | Resignation in August 2011 of certain employees involved in concealing the related party nature of the Wang Loan;
|-- | -----------------------------------------------------------------------------------------------------------------



|4) | Appointment of an Independent Controller reporting to the Audit Committee of the Board of Directors;
|-- | ----------------------------------------------------------------------------------------------------



|5) | Re-engagement of Ernst & Young Advisory to further improve procedures required to comply with the internal control over financial reporting and disclosure control provisions of the Sarbanes Oxley Act and to provide training to employees regarding U.S. GAAP, internal controls over financial reporting and disclosure controls and procedures;
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|6) | Adopting a policy that restricts the signing authority of the Chairman and other executives.  The policy mandates two signing parties for any obligation outside the normal scope of operations set forth in the Company’s business plan, as reviewed and approved from time to time by the Company’s Board of Directors; and
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|7) | Engagement of Grant Thornton as U.S. GAAP consultant to the Company for purposes of preparing its quarterly and annual periodic reports.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------



All the above items have been completed.



In addition, the Company continues to reassess its internal controls
and procedures in light of these recent events and is in the process of determining additional appropriate actions to take to remediate
these material weaknesses.



Changes in Internal Control over Financial Reporting



Other than the remediation measures described above, there was no
change in our internal control over financial reporting during the quarter ended March 31, 2011 that has materially affected, or
is reasonably likely to materially affect, our internal control over financial reporting.



42







Part II. OTHER INFORMATION



Item 1.  Legal Proceedings



|a) | The Company and certain of its officers and directors have been named as defendants in a putative class action lawsuit alleging violations of the federal securities laws. That action, captionedVandevelde v. China Natural Gas, Inc. , et al., C.A. No. 10-728, was filed on August 26, 2010 in the United States District Court for the District of Delaware. The plaintiff inVandevelde asserts that the Company, Qinan Ji, Zhiqiang Wang, Donald Yang, David She, Carl Yeung and Lawrence Leighton violated Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder, when it failed to disclose and properly account for the Loan in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 and Quarterly Report on Form 10-Q for the quarter ended March 31, 2010. The complaint alleges that the Pledge to secure the Loan violated the Indenture for the Senior Notes and the warrant agreement relating to the warrants issued to Abax, giving the holder of those notes and warrants the right to declare a default under the Indenture. The complaint further alleges that, on August 20, 2010, the Company amended its Annual Report on Form 10-K for the year ended December 31, 2009 and Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 to disclose the Loan and restate its financial statements in light of the note and warrant holder’s right to declare a default under the Indenture, and that the announcement of this news caused the price of our stock to drop by twenty percent. The plaintiff seeks damages in an unspecified amount to recover the losses purportedly suffered by the putative class as a result of that decline. The complaint also asserts claims against the individual defendants as controlling persons of the Company for violations of Section 20(a) of the Securities Exchange Act of 1934.
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



A second action, captionedBaranowski v. China Natural Gas, Inc.,
et al., Case No. 10-6572, was filed on September 3, 2010 in the United States District Court for the Southern District of New
York. The plaintiff in that action, which was based on the same claims as those asserted by the plaintiff inVandevelde
and on substantially similar allegations, voluntarily dismissed the action without prejudice on November 23, 2010.



Two putative class members in theVandevelde action have
moved for appointment as lead plaintiff. After the Court decides those motions, the putative class member who is appointed
lead plaintiff will have an opportunity to file an amended complaint. The defendants will not be required to answer or otherwise
respond to the complaint until after the lead plaintiff either decides to proceed on the basis of the original complaint or files
an amended complaint.



The Company intends to defend this case vigorously. The Company
currently cannot estimate the outcome of this litigation as of the date of this report.



|b) | A former member of the board of directors filed a lawsuit on June 16, 2008 against the Company in New York State Supreme Court, Nassau County, in which he has sought, among other things, to recover a portion of his monthly compensation plus 20,000 options that he alleges are due to him pursuant to a written agreement. After the plaintiff rejected an offer by the Company that included the options that plaintiff alleged were due to him, the Company moved to dismiss the complaint. The judge ordered the Company to issue the 20,000 options to the plaintiff subject to any restrictions required by applicable securities laws, which was essentially what the Company had previously offered, and dismissed all of the plaintiff's remaining claims against the Company. The current board of directors has complied with the court's decision by tendering an option agreement to the plaintiff consistent with the court's decision, but the plaintiff has refused to execute the agreement, and instead has filed an appeal. On March 16, 2010, the Supreme Court of the State of New York denied the motion for leave to appeal. We believe the case will not have any material adverse effect on our financial condition or our results of operations.
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Item 1A.  Risk Factors



As of the date of this filing, there have been no material changes
from the risk factors disclosed in Part I, Item 1A (Risk Factors) contained in the 2010 Annual Report other than as set forth below.
We operate in a changing environment that involves numerous known and unknown risks and uncertainties that could materially affect
our operations. The risks, uncertainties and other factors set forth in our Annual Report on Form 10-K may cause our actual results,
performances and achievements to be materially different from those expressed or implied by our forward-looking statements. If
any of these risks or events occurs, our business, financial condition or results of operations may be adversely affected.



We have made errors in the preparation of
certain of our historical financial statements and our internal control over financial reporting and disclosure controls and procedures
have not been effective.



Because of the material weaknesses in our internal
control over financial reporting and the ineffectiveness of our disclosure controls and procedures, we could be subject to sanctions
or investigations by the exchange on which we list our shares, the SEC or other regulatory authorities. The SEC has commenced an
investigation into the matters surrounding the Wang Loan and the acquisition of Lingbao Yuxi Natural Gas Co., Ltd. The Company
is cooperating with the investigation. In addition, the NASDAQ has halted trading in the Company’s common stock pending its
request for additional information from the Company with respect to these matters and the filing of the restated quarterly reports
on Form 10-Q/A for the three months ended March 31, 2010, the six months ended June 30, 2010 and the nine months ended September
30, 2010, and a restated annual report on Form 10-K/A for the year ended December 31, 2010. The SEC may take enforcement action
against the Company and the NASDAQ may seek to delist the Company’s stock. The market price of our common stock has declined
and because of these events, investor perceptions of our company may suffer, and this could cause a further decline in the market
price of our stock. If we are unable to remediate the material deficiencies in our internal control effectively or efficiently,
it could harm our operations, financial reporting or financial results and could result in an adverse opinion on internal controls
from our independent registered public accounting firm. In addition, we may identify additional material weaknesses in the future.
Any additional failures of internal controls could have a material adverse effect on our results of operations and harm our reputation.



Item 2.  Unregistered Sales of Equity Securities and
Use of Proceeds



None.



Item 3.  Defaults upon Senior Securities



None.



Item 4.  (Removed and Reserved)



Item 5.  Other Information



None.



43







Item 6.  Exhibits



|Exhibit
        Number |  | Description of Exhibit                                                                                                                                         
|---------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.1*                  |  | Certification of Principal Executive Officer pursuant to Rule 13a-14 and Rule 15d-14(a), promulgated under the Securities and Exchange Act of 1934, as amended.
|31.2*                  |  | Certification of Principal Financial Officer pursuant to Rule 13a-14 and Rule 15d 14(a), promulgated under the Securities and Exchange Act of 1934, as amended.
|32.1*                  |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer).              
|32.2*                  |  | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer)               



SIGNATURES



In accordance with the requirements of the
Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                   | China Natural Gas, Inc.
|------------------ | -----------------------
|                   |                        
|February    , 2012 | By:                    
|                   |                        
|                   |                        
|                   |                        



|                   |     |                                             
|------------------ | --- | --------------------------------------------
|February    , 2012 | By: | /s/ Bode Xu                                 
|                   |     | Bode Xu                                     
|                   |     | Chief Financial Officer                     
|                   |     | (Principal Financial and Accounting Officer)





44