UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q




(Mark
One)


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




For
the quarterly period ended June 30, 2009





 ̈
            TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE
  ACT





For the
transition period from ____________ to __________




000-31539


(Commission
file number)





CHINA
NATURAL GAS, INC.


(Exact
name of registrant as specified in its charter)





Delaware
            98-0231607(State
      or other jurisdiction of incorporation or organization)
            (IRS
      Employer of Identification No.)




19th
Floor, Building B, Van Metropolis


Tang Yan
Road, Hi-Tech Zone


Xi’an,
710065, Shaanxi Province, China


(Address
of principal executive offices)







(zip
code)




86-29-8832-7391


(registrant
's telephone number, including area code)





N/A


(Former
name, former address and former fiscal year, if changed since last
report)





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.


YesxNo ̈





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
      filerxNon-accelerated
      filer ̈
            Smaller
      reporting company ̈


(Do not
check if a smaller reporting company)





Number of
shares of Common Stock outstanding as of August 1, 2009: 14,600,154


Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


Yes ̈ Nox







China
Natural Gas, Inc.


Index





PART
      I.
                  FINANCIAL
      INFORMATIONItem
      1.
                  Financial
      Statements
                  
                  1Notes
      to Consolidated Financial Statements (unaudited)
                  
                  4Item
      2.
                  Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
                  
                  23Item
      3.
                  Quantitative
      and Qualitative Disclosures About Market Risk
                  
                  39Item
      4.
                  Controls
      and Procedures
                  
                  40PART
      II.
                  OTHER
      INFORMATIONItem
      1.
                  Legal
      Proceedings
                  
                  40Item
      1A.
                  Risk
      Factors
                  
                  41Item
      2.
                  Unregistered
      Sales of Equity Securities and Use of Proceeds
                  
                  41Item
      3.
                  Defaults
      Upon Senior Securities
                  
                  41Item
      4.
                  Submission
      of Matters to a Vote of Security Holders
                  
                  41Item
      5.
                  Other
      Information
                  
                  41Item
      6.
                  Exhibits
                  
                  41SIGNATURES
                  
                  42





PART
I. FINANCIAL INFORMATION


Item
1. Financial Statements


CHINA
NATURAL GAS, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS


AS
OF JUNE 30, 2009 AND DECEMBER 31, 2008





June
      30,
                                
                                
                                December,
      312009
                                
                                
                                2008(Unaudited)ASSETSCURRENT
      ASSETS:Cash
      & cash equivalents
                                
                                $
                                9,701,176
                                
                                
                                $
                                5,854,383Accounts
      receivable
                                
                                
                                979,179
                                
                                
                                
                                906,042Other
      receivable - employee advances
                                
                                
                                152,813
                                
                                
                                
                                332,263Inventories
                                
                                
                                1,196,791
                                
                                
                                
                                519,739Advances
      to suppliers
                                
                                
                                1,105,243
                                
                                
                                
                                837,592Prepaid
      expense and other current assets
                                
                                
                                558,868
                                
                                
                                
                                838,294Loan
      receivable
                                
                                
                                293,000
                                
                                
                                
                                293,400Total
      current assets
                                
                                
                                13,987,070
                                
                                
                                
                                9,581,713PROPERTY
      AND EQUIPMENT, NET
                                
                                
                                73,104,770
                                
                                
                                
                                76,028,272CONSTRUCTION
      IN PROGRESS
                                
                                
                                33,644,992
                                
                                
                                
                                22,061,414DEFERRED
      FINANCING COSTS
                                
                                
                                1,541,914
                                
                                
                                
                                1,746,830OTHER
      ASSETS
                                
                                
                                9,021,067
                                
                                
                                
                                8,844,062TOTAL
      ASSETS
                                
                                $
                                131,299,813
                                
                                
                                $
                                118,262,291LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable and accrued liabilities
                                
                                $
                                1,621,773
                                
                                
                                $
                                800,013Other
      payables
                                
                                
                                197,161
                                
                                
                                
                                124,151Unearned
      revenue
                                
                                
                                1,969,317
                                
                                
                                
                                944,402Accrued
      interest
                                
                                
                                1,237,778
                                
                                
                                
                                861,114Taxes
      payable
                                
                                
                                2,166,889
                                
                                
                                
                                1,862,585Total
      current liabilities
                                
                                
                                7,192,918
                                
                                
                                
                                4,592,265LONG
      TERM LIABILITIES:Notes
      payable, net of discount of $14,167,334 and $15,478,395 as
    ofJune
      30, 2009 and December 31, 2008, respectively
                                
                                
                                25,832,666
                                
                                
                                
                                24,521,605Redeemable
      liabilities - warrants
                                
                                
                                17,500,000
                                
                                
                                
                                17,500,000Derivative
      liabilities - warrants
                                
                                
                                2,130,091
                                
                                
                                
                                -Total
      long term liabilities
                                
                                
                                45,462,757
                                
                                
                                
                                42,021,605COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS'
      EQUITY:Preferred
      stock, $0.0001 per share; 5,000,000 shares authorized; none
      issued
                                
                                
                                
                                
                                
                                
                                -Common
      stock, $0.0001 per share; 45,000,000 shares authorized, 14,600,154
      sharesissued
      and outstanding at June 30, 2009 and December 31, 2008
                                
                                
                                1,460
                                
                                
                                
                                1,460Additional
      paid-in capital
                                
                                
                                25,357,254
                                
                                
                                
                                32,115,043Cumulative
      translation adjustment
                                
                                
                                8,505,948
                                
                                
                                
                                8,661,060Statutory
      reserves
                                
                                
                                4,880,681
                                
                                
                                
                                3,730,083Retained
      earnings
                                
                                
                                39,898,795
                                
                                
                                
                                27,140,775Total
      stockholders' equity
                                
                                
                                78,644,138
                                
                                
                                
                                71,648,421TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                                
                                $
                                131,299,813
                                
                                
                                $
                                118,262,291


The
accompanying notes are an integral part of these statements


1


CHINA
NATURAL GAS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME


FOR
THE THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008


(Unaudited)





Three
      months ended
                                                                                      
                                                                                      
                                                                                      Six
      months endedJune
      30
                                                                                      
                                                                                      
                                                                                      June
      302009
                                                                                      
                                                                                      
                                                                                      2008
                                                                                      
                                                                                      
                                                                                      2009
                                                                                      
                                                                                      
                                                                                      2008RevenueNatural
      gas revenue
                                                                                      
                                                                                      $
                                                                                      15,720,679
                                                                                      
                                                                                      
                                                                                      $
                                                                                      13,794,866
                                                                                      
                                                                                      
                                                                                      $
                                                                                      30,686,498
                                                                                      
                                                                                      
                                                                                      $
                                                                                      25,140,185Gasoline
      revenue
                                                                                      
                                                                                      
                                                                                      1,633,016
                                                                                      
                                                                                      
                                                                                      
                                                                                      1,148,097
                                                                                      
                                                                                      
                                                                                      
                                                                                      2,807,414
                                                                                      
                                                                                      
                                                                                      
                                                                                      2,278,847Installation
      and other
                                                                                      
                                                                                      
                                                                                      3,388,825
                                                                                      
                                                                                      
                                                                                      
                                                                                      1,947,523
                                                                                      
                                                                                      
                                                                                      
                                                                                      5,776,274
                                                                                      
                                                                                      
                                                                                      
                                                                                      3,497,128Total
      revenue
                                                                                      
                                                                                      
                                                                                      20,742,520
                                                                                      
                                                                                      
                                                                                      
                                                                                      16,890,486
                                                                                      
                                                                                      
                                                                                      
                                                                                      39,270,186
                                                                                      
                                                                                      
                                                                                      
                                                                                      30,916,160Cost
      of revenueNatural
      gas cost
                                                                                      
                                                                                      
                                                                                      7,490,518
                                                                                      
                                                                                      
                                                                                      
                                                                                      7,214,469
                                                                                      
                                                                                      
                                                                                      
                                                                                      14,237,447
                                                                                      
                                                                                      
                                                                                      
                                                                                      13,396,743Gasoline
      cost
                                                                                      
                                                                                      
                                                                                      1,529,752
                                                                                      
                                                                                      
                                                                                      
                                                                                      1,054,978
                                                                                      
                                                                                      
                                                                                      
                                                                                      2,659,809
                                                                                      
                                                                                      
                                                                                      
                                                                                      2,123,015Installation
      and other
                                                                                      
                                                                                      
                                                                                      1,444,060
                                                                                      
                                                                                      
                                                                                      
                                                                                      955,276
                                                                                      
                                                                                      
                                                                                      
                                                                                      2,461,088
                                                                                      
                                                                                      
                                                                                      
                                                                                      1,642,163Total
      cost of revenue
                                                                                      
                                                                                      
                                                                                      10,464,330
                                                                                      
                                                                                      
                                                                                      
                                                                                      9,224,723
                                                                                      
                                                                                      
                                                                                      
                                                                                      19,358,344
                                                                                      
                                                                                      
                                                                                      
                                                                                      17,161,921Gross
      profit
                                                                                      
                                                                                      
                                                                                      10,278,190
                                                                                      
                                                                                      
                                                                                      
                                                                                      7,665,763
                                                                                      
                                                                                      
                                                                                      
                                                                                      19,911,,842
                                                                                      
                                                                                      
                                                                                      
                                                                                      13,754,239Operating
      expensesSelling
      expenses
                                                                                      
                                                                                      
                                                                                      2,331,739
                                                                                      
                                                                                      
                                                                                      
                                                                                      1,568,674
                                                                                      
                                                                                      
                                                                                      
                                                                                      4,655,967
                                                                                      
                                                                                      
                                                                                      
                                                                                      2,910,288General
      and administrative expenses
                                                                                      
                                                                                      
                                                                                      1,182,399
                                                                                      
                                                                                      
                                                                                      
                                                                                      1,040,000
                                                                                      
                                                                                      
                                                                                      
                                                                                      2,864,320
                                                                                      
                                                                                      
                                                                                      
                                                                                      1,979,325Total
      operating expenses
                                                                                      
                                                                                      
                                                                                      3,514,138
                                                                                      
                                                                                      
                                                                                      
                                                                                      2,608,674
                                                                                      
                                                                                      
                                                                                      
                                                                                      7,520,287
                                                                                      
                                                                                      
                                                                                      
                                                                                      4,889,613Income
      from operations
                                                                                      
                                                                                      
                                                                                      6,764,052
                                                                                      
                                                                                      
                                                                                      
                                                                                      5,057,089
                                                                                      
                                                                                      
                                                                                      
                                                                                      12,391,555
                                                                                      
                                                                                      
                                                                                      
                                                                                      8,864,626Non-operating
      income (expense)Interest
      income
                                                                                      
                                                                                      
                                                                                      7,784
                                                                                      
                                                                                      
                                                                                      
                                                                                      51,476
                                                                                      
                                                                                      
                                                                                      
                                                                                      16,692
                                                                                      
                                                                                      
                                                                                      
                                                                                      106,761Interest
      expense
                                                                                      
                                                                                      
                                                                                      (388,618
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (676,569
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (970,110
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (1,036,229
                                                                                      )Other
      income (expense), net
                                                                                      
                                                                                      
                                                                                      (20,926
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (3,600
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (23,229
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (10,726
                                                                                      )Change
      in fair value of warrants
                                                                                      
                                                                                      
                                                                                      (1,312,834
                                                                                      )
                                                                                      
                                                                                      
                                                                                      -
                                                                                      
                                                                                      
                                                                                      
                                                                                      (1,115,783
                                                                                      )
                                                                                      
                                                                                      
                                                                                      -Foreign
      currency exchange loss
                                                                                      
                                                                                      
                                                                                      (19
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (52,831
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (50,807
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (52,831
                                                                                      )Total
      non-operating expense
                                                                                      
                                                                                      
                                                                                      (1,714,613
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (681,524
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (2,143,237
                                                                                      )
                                                                                      
                                                                                      
                                                                                      (993,025
                                                                                      )Income
      before income tax
                                                                                      
                                                                                      
                                                                                      5,049,439
                                                                                      
                                                                                      
                                                                                      
                                                                                      4,375,565
                                                                                      
                                                                                      
                                                                                      
                                                                                      10,248,318
                                                                                      
                                                                                      
                                                                                      
                                                                                      7,871,601Provision
      for income tax
                                                                                      
                                                                                      
                                                                                      1,186,683
                                                                                      
                                                                                      
                                                                                      
                                                                                      862,673
                                                                                      
                                                                                      
                                                                                      
                                                                                      2,183,939
                                                                                      
                                                                                      
                                                                                      
                                                                                      1,550,138Net
      income
                                                                                      
                                                                                      
                                                                                      3,862,756
                                                                                      
                                                                                      
                                                                                      
                                                                                      3,512,892
                                                                                      
                                                                                      
                                                                                      
                                                                                      8,064,379
                                                                                      
                                                                                      
                                                                                      
                                                                                      6,321,463Other
      comprehensive incomeForeign
      currency translation gain (loss)
                                                                                      
                                                                                      
                                                                                      (2,997
                                                                                      )
                                                                                      
                                                                                      
                                                                                      1,494,722
                                                                                      
                                                                                      
                                                                                      
                                                                                      (155,112
                                                                                      )
                                                                                      
                                                                                      
                                                                                      3,797,724Comprehensive
      income
                                                                                      
                                                                                      $
                                                                                      3,859,759
                                                                                      
                                                                                      
                                                                                      $
                                                                                      5,007,614
                                                                                      
                                                                                      
                                                                                      $
                                                                                      7,909,267
                                                                                      
                                                                                      
                                                                                      $
                                                                                      10,119,187Weighted
      average shares outstandingBasic
                                                                                      
                                                                                      
                                                                                      14,600,154
                                                                                      
                                                                                      
                                                                                      
                                                                                      14,600,154
                                                                                      
                                                                                      
                                                                                      
                                                                                      14,600,154
                                                                                      
                                                                                      
                                                                                      
                                                                                      14,600,154Diluted
                                                                                      
                                                                                      
                                                                                      14,726,647
                                                                                      
                                                                                      
                                                                                      
                                                                                      14,661,748
                                                                                      
                                                                                      
                                                                                      
                                                                                      14,600,154
                                                                                      
                                                                                      
                                                                                      
                                                                                      14,664,867Earnings
      per shareBasic
                                                                                      
                                                                                      $
                                                                                      0.26
                                                                                      
                                                                                      
                                                                                      $
                                                                                      0.24
                                                                                      
                                                                                      
                                                                                      $
                                                                                      0.55
                                                                                      
                                                                                      
                                                                                      $
                                                                                      0.43Diluted
                                                                                      
                                                                                      $
                                                                                      0.26
                                                                                      
                                                                                      
                                                                                      $
                                                                                      0.24
                                                                                      
                                                                                      
                                                                                      $
                                                                                      0.55
                                                                                      
                                                                                      
                                                                                      $
                                                                                      0.43




The
accompanying notes are an integral part of these statements


2





CHINA
NATURAL GAS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


FOR
THE SIX MONTHS ENDED JUNE 30, 2009 AND 2008


(Unaudited)




Six
      Months Ended June 30,2009
                  
                  
                  2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                  
                  $
                  8,064,379
                  
                  
                  $
                  6,321,463Adjustments
      to reconcile net income to net cashprovided
      by operating activities:Depreciation
      and amortization
                  
                  
                  2,782,209
                  
                  
                  
                  1,358,378Loss
      on disposal of equipment
                  
                  
                  21,370
                  
                  
                  
                  12,134Amortization
      of discount on senior notes
                  
                  
                  217,196
                  
                  
                  
                  459,473Amortization
      of financing costs
                  
                  
                  52,435
                  
                  
                  
                  122,592Stock
      based compensation
                  
                  
                  100,758
                  
                  
                  
                  38,896Change
      in fair value of warrants
                  
                  
                  1,115,783
                  
                  
                  
                  -Change
      in assets and liabilities:Accounts
      receivable
                  
                  
                  (74,409
                  )
                  
                  
                  (513,994
                  )Other
      receivable - employee advances
                  
                  
                  109,963
                  
                  
                  
                  101,267Inventories
                  
                  
                  (487,908
                  )
                  
                  
                  (269,136
                  )Advances
      to suppliers
                  
                  
                  (268,922
                  )
                  
                  
                  (279,741
                  )Prepaid
      expense and other current assets
                  
                  
                  157,372
                  
                  
                  
                  (637,244
                  )Accounts
      payable and accrued liabilities
                  
                  
                  822,997
                  
                  
                  
                  (11,440
                  )Other
      payables
                  
                  
                  73,210
                  
                  
                  
                  8,525Unearned
      revenue
                  
                  
                  1,026,693
                  
                  
                  
                  530,551Accrued
      interest
                  
                  
                  376,664
                  
                  
                  
                  454,164Taxes
      payable
                  
                  
                  306,975
                  
                  
                  
                  430,244Net
      cash provided by operating activities
                  
                  
                  14,396,765
                  
                  
                  
                  8,126,132CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment
                  
                  
                  (21,033
                  )
                  
                  
                  (12,471,764
                  )Proceeds
      from sales of property and equipment
                  
                  
                  41,305
                  
                  
                  
                  -Proceeds
      from short term investments
                  
                  
                  -
                  
                  
                  
                  246,802Additions
      to construction in progress
                  
                  
                  (10,372,858
                  )
                  
                  
                  (11,736,887
                  )Change
      in prepayment on long term assets
                  
                  
                  (110,836
                  )
                  
                  
                  (3,559,485
                  )Return
      of acquisition deposit
                  
                  
                  449,910Payment
      for intangible assets
                  
                  
                  (66,971
                  )
                  
                  
                  -Payment
      for land use rights
                  
                  
                  (463,870
                  )
                  
                  
                  (36,341
                  )Increase
      in stockholder receivable
                  
                  
                  -
                  
                  
                  
                  (2,836,800
                  )Net
      cash used in investing activities
                  
                  
                  (10,544,353
                  )
                  
                  
                  (30,394,475
                  )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from senior notes
                  
                  
                  -
                  
                  
                  
                  40,000,000Payment
      for offering costs
                  
                  
                  -
                  
                  
                  
                  (2,122,509
                  )Net
      cash provided by financing activities
                  
                  
                  -
                  
                  
                  
                  37,877,491Effect
      of exchange rate changes on cash and cash equivalents
                  
                  
                  (5,619
                  )
                  
                  
                  279,438NET
      INCREASE IN CASH & CASH EQUIVALENTS
                  
                  
                  3,846,793
                  
                  
                  
                  15,888,586CASH
      & CASH EQUIVALENTS, BEGINNING OF PERIOD
                  
                  
                  5,854,383
                  
                  
                  
                  13,291,729CASH
      & CASH EQUIVALENTS, END OF PERIOD
                  
                  $
                  9,701,176
                  
                  
                  $
                  29,180,315SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Interest
      paid, net of capitalized interest
                  
                  $
                  237,641
                  
                  
                  $
                  -Income
      taxes paid
                  
                  $
                  1,934,887
                  
                  
                  $
                  1,203,048





The
accompanying notes are an integral part of these
statements


3




China
Natural Gas, Inc. and Subsidiaries


Notes
to Consolidated Financial Statements


June
30, 2009


(Unaudited)





Note
1 - Organization





Organization and Line of
Business





China
Natural Gas, Inc. (the “Company” or “CHNG”) was incorporated in the state of
Delaware on March 31, 1999. The Company through its wholly-owned subsidiaries
and variable interest entities, located in Shaanxi and Henan 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,
construction of pipeline networks, installation of natural gas fittings and
parts for end-users, and modification of automobiles services for vehicles to be
able to use natural gas.





RecentDevelopments





On March
18, 2008, Shaanxi Xilan Natural Gas Equipment Co., Ltd (“SXNGE”) increased its
registered capital from $30,000,000 to $53,929,260.  The additional
$14,429,260 of registered capital was contributed by China Natural Gas, Inc. on
April 17, 2008 and $9,500,000 of registered capital was contributed by China
Natural Gas, Inc. as a payment to Chemtex International Inc. on January 31,
2008, for the purchase of license, know-how, and design of constructing the
Liquefied Natural Gas (“LNG”) processing plant.





On April
22, 2008, Jingbian Liquefied Natural Gas Co., Ltd. (“JBLNG”) increased its
registered capital by $2,862,000.  JBLNG is 100% owned by Xi’an Xilan
Natural Gas Co., Ltd.





On April
30, 2008, the Industrial and Commercial Administration Bureau approved Xi’an
Xilan Natural Gas Co., (“XXNGC”) to increase registered capital from $8,336,856
to $43,443,640 as an additional contribution by the shareholders of XXNGC under
PRC Law. $15,513,526 was approved by the Industrial and Commercial
Administration Bureau to be transferred out from the surplus reserve and
retained earnings as an increase of registered capital.  Another
$19,593,258 was contributed by SXNGE cumulatively prior to April 30, 2008, which
was previously classified as an intercompany payable in XXNGC and was eliminated
in the consolidated financial statements.  The increase in registered
capital in XXNGC was in compliance with the Addendum to Option Agreement entered
by the Company through SXNGE and XXNGC, Mr. Qinan Ji, chairman and shareholder
of XXNGC, and each of the shareholders of XXNGC (hereafter collectively referred
to as the “Transferor”) on August 8, 2008, and made retroactive to June 30,
2008.  See “Consolidation of Variable Interest Entity” section for
further detail on the Addendum to Option Agreement.





On July
3, 2008, XXNGC formed Henan Xilan Natural Gas Co., Ltd. (“HXNGC”) as a wholly
owned limited liability company, with registered capital of $4,383,000 in Henan
province, PRC.  HXNGC was established for the purpose of natural gas
city gasification engineering design, construction and technical advisory work
services in Henan, PRC.





On
October 2, 2008, China Natural Gas, Inc. (the “Company”) through its
wholly-owned subsidiary, XXNGC, entered into an Equity Ownership Transfer
Agreement (the “Acquisition Agreement”) with Lingbao Yuxi Natural Gas Co., Ltd.
(“LBNGC”) and the shareholders of LBNGC (the “Sellers”).  Pursuant to
the term of the Acquisition Agreement, XXNGC acquired for cash consideration of
approximately $19,604,200 (RMB 134 million), 100% of all outstanding registered
equity interest in LBNGC and all assets held by LBNGC, including the land use
right to 0.44 acres and all of LBNGC’s local business’ exclusive operating
rights. LBNGC owns the exclusive rights to operate CNG fueling stations and
pipelines in Lingbao City. In conjunction with this acquisition, XXNGC has also
secured an abundant supply of natural gas to support its future expansion in the
Henan province. The Acquisition Agreement was fully executed in November,
2008.


4


Note
2 – Summary of Significant Accounting Policies





Basis of
Presentation





The
accompanying consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of
America.  The Company’s functional currency is the Chinese Renminbi
(“RMB”); however, the Company’s reporting currency is the United States Dollar
(“USD”); therefore, the accompanying consolidated financial statements have been
translated and presented in USD.





In the
opinion of management, the unaudited consolidated financial statements furnished
herein include all adjustments, all of which are of a normal recurring nature,
necessary for a fair statements of the results for the interim period
presented.  Operating results for the period ended June 30, 2009 are
not necessary indicative of the results that may be expected for the year ended
December 31, 2009. The information included in this Form 10-Q should be
read in conjunction with information included in the 2008 annual report filed on
Form 10-K/A.





Use of
Estimates





The
preparation of financial statements in conformity with generally accepted
accounting principles 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.
Actual results could differ from those estimates.





Principles of
Consolidation





The
accompanying consolidated financial statements include the accounts of China
Natural Gas, Inc. and its wholly owned subsidiary, Shaanxi Xilan Natural
Gas Equipment Co., Ltd and its 100% variable interest entities (“VIE”), Xi’an
Xilan Natural Gas Co. Ltd., Jingbian Liquefied Natural Gas Co., Ltd., Shaanxi
Xilan Auto Bodyshop Co., Ltd. (“SXABC”), Henan Xilan Natural Gas Co., Ltd., and
Lingbao Yuxi Natural Gas Co., Ltd.  All inter-company accounts and
transactions have been eliminated in the consolidation.





Consolidation of Variable
Interest Entity





In
accordance with Financial Interpretation No. 46R, Consolidation of Variable
Interest Entities ("FIN 46R"), VIEs are generally 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. All
VIEs with which the Company is involved must be evaluated to determine the
primary beneficiary of the risks and rewards of the VIE. The primary beneficiary
is required to consolidate the VIE for financial reporting
purposes.





On
February 21, 2006, the Company formed Shaanxi Xilan Natural Gas Equipment Co.,
Ltd as a wholly-owned foreign enterprise (WOFE). Then through SXNGE, the Company
entered into exclusive arrangements with Xi’an Xilan Natural Gas and its
shareholders that give the Company the ability to substantially influence Xi’an
Xilan Natural Gas’ daily operations and financial affairs, appoint its senior
executives and approve all matters requiring shareholder approval. The Company
memorialized these arrangements on August 17, 2007 and made retroactive to March
8, 2006.  As a result, the Company consolidates the financial results
of Xi’an Xilan Natural Gas as variable interest entity pursuant to Financial
Interpretation No. 46R, “Consolidation of Variable Interest Entities.” The
arrangements consist of the following agreements:




a.
            Xi’an
      Xilan Natural Gas holds the licenses and approvals necessary to operate
      its natural gas business in China.





b.
            SXNGE
      provides exclusive technology consulting and other general business
      operation services to Xi’an Xilan Natural Gas in return for a consulting
      services fee which is equal to Xi’an Xilan Natural Gas’s
      revenue.





c.
            Xi’an
      Xilan Natural Gas’ shareholders have pledged their equity interests
      in Xi’an Xilan Natural Gas to the
Company.


5


d.
            Irrevocably
      granted the Company an exclusive option to purchase, to the extent
      permitted under PRC law, all or part of the equity interests in Xi’an
      Xilan Natural Gas and agreed to entrust all the rights to exercise their
      voting power to the person appointed by the
  Company.





On August
8, 2008, the Company through SXNGE entered into an Addendum to Option
Agreement with Mr. Qinan Ji, chairman and shareholder of XXNGC, and each of
the shareholders of XXNGC (hereafter collectively referred to as the
“Transferor”), and made retroactive to June 30, 2008.  According to
the Agreement, the Chairman and the Shareholders of XXNGC irrevocably grants to
SXNGE an option to purchase each Transferor’s Purchased Equity Interest at $1.00
or the lowest price permissible under the applicable laws at the time that SXNGE
exercises the Option.  The Agreement limits XXNGC and the transferors’
right to make all equity interest related decisions.





Foreign Currency
Translation





As of
June 30, 2009 and December 31, 2008, the accounts of the Company were
maintained, and their consolidated financial statements were expressed in
RMB.  Such consolidated financial statements were translated into USD
in accordance with Statement of Financial Accounts Standards ("SFAS") 52,
"Foreign Currency Translation," with the RMB as the functional currency.
According to SFAS 52, all assets and liabilities were translated at the exchange
rate as of the balance sheet date, stockholders’ equity were translated at the
historical rates and statement of income and cash flow items were translated at
the weighted average exchange rate for the year. The resulting translation
adjustments are reported under other comprehensive income in accordance with
SFAS 130, "Reporting Comprehensive Income."  In accordance with SFAS
95, "Statement of Cash Flows," cash flows from the Company's operations are
calculated based upon the local currencies and translated to USD at average
translation rates for the period. As a result, translation adjustments amount
related to assets and liabilities reported on the consolidated statement of cash
flows will not necessarily agree with changes in the corresponding consolidated
balances on the balance sheet.





The
balance sheet amounts with the exception of equity at June 30, 2009, were
translated 6.83 RMB to $1.00 as compared to 6.82 RMB at December 31, 2008. The
equity accounts were stated at their historical rate. The average translation
rates applied to income and cash flow statement amounts for the six months ended
June 30, 2009 and 2008, were 6.82 RMB and 7.05 RMB to $1.00,
respectively.





Cash and Cash
Equivalents





Cash and
cash equivalents include cash on hand and demand deposits in accounts maintained
with state-owned banks within the PRC and the United States. The Company
considers all highly liquid investments with original maturities of three months
or less at the time of purchase to be cash equivalents.





Certain
financial instruments, which subject the Company to concentration of credit
risk, consist of cash. The Company maintains balances at financial institutions
which, from time to time, may exceed Federal Deposit Insurance Corporation
insured limits for the banks located in the United States. Balances at financial
institutions or state-owned banks within the PRC are not covered by insurance.
As of June 30, 2009 and December 31, 2008, the Company had total deposits of
$9,528,913 and $5,604,383 without insurance coverage.  And as of June
30, 2009 and December 31, 2008, the Company had deposits in the United States of
$0 and $1,273,639 in excess of federally insured limits, respectively. The
Company has not experienced any losses in such accounts and believes it is not
exposed to any significant risks on its cash in bank accounts.





Accounts
Receivable





Accounts
and other receivable are netted against an allowance for uncollectible accounts,
as needed.  The Company maintains reserves for potential credit losses
on accounts receivable.  Management 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 these reserves. Reserves are
recorded primarily on a specific identification basis in the period of the
related sales. 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’s management has determined that all receivables are collectible and
there is no need for an allowance for uncollectible accounts as of June 30,
2009, and December 31, 2008.


6





Other Receivable – Employee
Advances





From time
to time, the Company advances predetermined amounts based upon internal Company
policy to certain employees and internal units to ensure certain transactions
are performed in a timely manner. The Company has full oversight and control
over the advanced accounts. As of June 30, 2009 and December 31, 2008, no
allowance for the uncollectible accounts was deemed necessary.





Inventory





Inventory
is stated at the lower of cost, as determined on a first-in, first-out basis, or
market.  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. Inventory consists of material used in the construction of
pipelines and material used in repairing and modifying
vehicles.  Inventory also consists of gasoline.





The
following are the details of the inventories:





June 30, 2009
                    (Unaudited)
                  
                  
                  December 31, 2008Materials and
      supplies
                  
                  $
                  829,466
                  
                  
                  $
                  318,069Gasoline
                  
                  
                  367,325
                  
                  
                  
                  201,670$
                  1,196,791
                  
                  
                  $
                  519,739





Advances to
Suppliers





The
Company advances to certain vendors for purchase of its materials. The advances
are interest-free and unsecured.





Loan
Receivable





Loan
receivable consists of the following:


June 30, 2009
                  (Unaudited)
                
                
                December 31, 2008Shanxi
      Yuojin Mining Company, due on November 26, 2008, extended to November 30,
      2009, annual interest at 6.57%
                
                $
                293,000
                
                
                $
                293,400





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. When property and equipment are retired or otherwise disposed of,
the related cost and accumulated depreciation are removed from the respective
accounts, and any gain or loss is included in
operations.  Depreciation of property and equipment is provided using
the straight-line method for substantially all assets with estimated lives as
follows:





Office
      equipment
              5
      yearsOperating
      equipment
              5-20
      yearsVehicles
              5
      yearsBuildings
      and improvements
              5-30
      years





7





The
following are the details of the property and equipment:





June 30, 2009
                    (Unaudited)
                  
                  
                  December 31, 2008Office equipment
                  
                  $
                  422,892
                  
                  
                  $
                  412,490Operating
      equipment
                  
                  
                  59,396,860
                  
                  
                  
                  59,473,283Vehicles
                  
                  
                  2,295,579
                  
                  
                  
                  2,414,756Buildings
      and improvements
                  
                  
                  21,167,110
                  
                  
                  
                  21,190,599Total
      property and equipment
                  
                  
                  83,282,441
                  
                  
                  
                  83,491,128Less
      accumulated depreciation
                  
                  
                  (10,177,671
                  )
                  
                  
                  (7,462,856
                  )Property
      and equipment, net
                  
                  $
                  73,104,770
                  
                  
                  $
                  76,028,272





Depreciation
expense for the three months ended June 30, 2009 and 2008 was $1,390,017 and
$701,854, respectively. Depreciation expense for the six months ended June 30,
2009 and 2008 was $2,779,582 and $1,358,378, respectively.





Construction inProgress





Construction
in progress (“CIP”) consists of the cost of constructing property and equipment
for the Company’s gas stations and a new project of processing, distribution and
sale of LNG. The major cost of construction in progress relates to technology
licensing fees, equipment purchase, 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
June 30, 2009 and December 31, 2008, the company had construction in progress in
the amount of $33,644,992 and 22,061,414, respectively. Interest cost
capitalized into construction in progress for the three months ended June 30,
2009 and 2008, amounted to $1,172,547 and $491,856, respectively. Interest
cost capitalized into construction in progress for the six months ended June 30,
2009 and 2008, amounted to $2,030,926 and $682,504, respectively





Construction
in progress at June 30, 2009 consisted of the following:





No.
                                        
                                        Project Description
                                        
                                        Location
                                        
                                        June 30, 2009
                                          (Unaudited)
                                        
                                        Commencement
                                          date
                                        
                                        Expected
                                          completion
                                          date
                                        
                                        Estimated
                                          additional
                                          cost to be
                                          completed1
                                        
                                        Jingbian
      LNG
                                        
                                        JBLNG
                                        
                                        $
                                        26,794,348
                                        
                                        Dec-06
                                        
                                        Dec-09
                                        
                                        $
                                        13,000,0002
                                        
                                        Shuan
      Fu mother station
                                        
                                        HXNGC
                                        
                                        
                                        722,802
                                        
                                        Jul-08
                                        
                                        Jun-11
                                        
                                        
                                        6,680,0003
                                        
                                        Zijing
      Energy mother station
                                        
                                        XXNGC
                                        
                                        
                                        4,087,998
                                        
                                        Sep-08
                                        
                                        May-11
                                        
                                        
                                        3,440,0004
                                        
                                        Xi'an
      Cangsheng mother station
                                        
                                        XXNGC
                                        
                                        
                                        1,835,428
                                        
                                        Sep-08
                                        
                                        May-11
                                        
                                        
                                        3,220,0005
                                        
                                        Other
      CIP projects
                                        
                                        XXNGC
                                        
                                        
                                        204,416
                                        
                                        Various
                                        
                                        Oct-09
                                        
                                        
                                        2,250,000$
                                        33,644,992
                                        
                                        
                                        
                                        
                                        
                                        $
                                        28,590,000





Long-Lived
Assets





The
Company applies the provision of SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" to all long lived assets. SFAS 144 addresses
accounting and reporting for impairment and disposal of long-lived assets. The
Company evaluates at least annually, more often when circumstances require, the
carrying value of long-lived assets to be held and used in accordance with SFAS
144.  SFAS 144 requires impairment losses to be 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 June 30, 2009, there were no significant impairments of its
long-lived assets.


8


Unearned
Revenue





Unearned
revenue represents prepayments by customers for gas purchases and advance
payments on installation of pipeline contracts. The Company records such
prepayment as unearned revenue when the payments are received.





Fair Value of Financial
Instruments





FAS 107,
“Disclosure About Fair Value of Financial Instruments” defines financial
instruments and requires fair value disclosure of applicable financial
instruments.  FAS 157, “Fair Value Measurements,” adopted January 1,
2008, defines fair value, establishes a three-level valuation hierarchy for
disclosures of fair value measurement and enhances 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:





●
              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
Company analyzes all financial instruments with features of both liabilities and
equity under SFAS 150, “Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity,” SFAS 133, “Accounting for
Derivative Instruments and Hedging Activities” and EITF 00-19, “Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock.”





Effective
January 1, 2009, the Company adopted the provisions of EITF 07-5,
"Determining Whether an Instrument (or Embedded Feature) is Indexed to an
Entity’s Own Stock”, which is effective for financial statements for fiscal
years beginning after December 15, 2008 and which replaced the previous guidance
on this topic in EITF 01-6.  Paragraph 11(a) of FAS 133 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 in stockholders’
equity in the statement of financial position would not be considered a
derivative financial instrument.  EITF 07-5 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 FAS
133 paragraph 11(a) scope exception.





As a
result of adopting EITF 07-5, 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 US dollar,
a currency other than the Company’s functional currency, the Chinese
Renminbi.  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 currently in earnings until such time as the
warrants are exercised or expire.





As such,
effective January 1, 2009, the Company reclassified the fair value of these
warrants from equity to liability, as if these warrants were treated as a
derivative liability since their issuance in October 2007. On
January 1, 2009, the Company reclassified from additional paid-in capital,
as a cumulative effect adjustment, $5,844,239 to beginning retained earnings and
$1,014,308 to warrant liabilities to recognize the fair value of such warrants.
The fair value of the warrants was $2,130,091 on June 30, 2009. The Company
recognized a $1,312,834 loss from the change in fair value of the three months
ended June 30, 2009. The Company recognized a $1,115,783 loss from the change in
fair value of warrants for the six months ended June 30, 2009.





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


9





June 30, 2009
                      
                      
                      January 1, 2009(Unaudited)Annual dividend
      yield
                      
                      
                      -
                      
                      
                      
                      -Expected
      life (years)
                      
                      
                      3.32
                      
                      
                      
                      3.82Risk-free
      interest rate
                      
                      
                      1.50
                      %
                      
                      
                      1.13
                      %Expected
      volatility
                      
                      
                      90
                      %
                      
                      
                      90
                      %





Expected
volatility is based on historical volatility.  Historical volatility was
computed using daily pricing observations for recent periods that correspond to
the term of the warrants. The Company believes this method produces an estimate
that is representative of our expectations of future volatility over the
expected term of these warrants. The Company has no reason to believe future
volatility over the expected remaining life of these warrants is likely to
differ materially from historical volatility. The expected life is based on the
remaining term of the warrants. The risk-free interest rate is based on U.S.
Treasury securities according to the remaining term of the
warrants.





As
required by SFAS 157, 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 the 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.





The
following table sets forth by level within the fair value hierarchy of the
Company’s financial assets and liabilities that were accounted for at fair value
on a recurring basis as of June 30, 2009.





Carrying Value at
                  June 30, 2009
                  (Unaudited)
                
                
                Fair Value Measurement at
                  June 30, 2009
                  (Unaudited)Level
      1
                
                
                Level
      2
                
                
                Level
      3Senior
      notes
                
                $
                25,832,666
                
                
                $
                -
                
                
                $
                -
                
                
                $
                34,660,250Redeemable
      liability - warrants
                
                
                17,500,000
                
                
                
                -
                
                
                
                -
                
                
                
                14,911,024Derivative
      liability - warrants
                
                
                2,130,091
                
                
                
                -
                
                
                
                2,130,091
                
                
                
                -Total
      liability measured at fair value
                
                $
                45,462,757
                
                
                $
                -
                
                
                $
                2,130,091
                
                
                $
                49,571,274





Other
than the derivative liabilities - warrants carried at fair value, the Company
did not identify any other assets and liabilities that are required to be
presented on the balance sheet at fair value in accordance with SFAS
157.





Revenue
Recognition





The
Company’s revenue recognition policies are in accordance with Staff Accounting
Bulletin (SAB) 104. Revenue is recognized when services are rendered to
customers 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. The 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.





Enterprise Wide
Disclosure





The
Company’s chief operating decision-makers (i.e. chief executive officer and his
direct reports) review financial information presented on a consolidated basis,
accompanied by disaggregated information about revenues by business lines for
purposes of allocating resources and evaluating financial performance. There are
no segment managers who are held accountable for operations, operating results
and plans for levels or components below the consolidated unit level. Based on
qualitative and quantitative criteria established by SFAS 131, “Disclosures
about Segments of an Enterprise and Related Information”, the Company considers
itself to be operating within one reportable segment.


10





Advertising
Costs





The
Company expenses the cost of advertising as incurred or, as appropriate, the
first time the advertising takes place. Advertising costs for the three and six
months ended June 30, 2009 and 2008, were insignificant.





Stock-Based
Compensation





The
Company records and reports stock-based compensation pursuant to SFAS 123R
“Accounting for Stock-Based Compensation”, which defines a fair-value-based
method of accounting for stock-based employee compensation and transactions in
which an entity issues its equity instruments to acquire goods and services from
non-employees. Stock compensation for stock granted to non-employees has been
determined in accordance with SFAS 123R and EITF 96-18, “Accounting for Equity
Instruments that are issued to Other than Employees for Acquiring, or in
Conjunction with Selling Goods or Services”, as the fair value of the
consideration received or the fair value of equity instruments issued, whichever
is more reliably measured.





Income
Taxes





The
Company utilizes SFAS 109, “Accounting for Income Taxes,” which 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. At June 30, 2009 and December 31, 2008, there
was no significant book to tax differences. There is no difference between book
depreciation and tax depreciation as the Company uses the same method for both
book and tax. The Company adopted FASB Interpretation 48, “Accounting for
Uncertainty in Income Taxes” (“FIN 48”), as of January 1, 2007. A 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. The adoption had no affect on the Company’s consolidated financial
statements.





Local PRC Income
Tax





The
Company’s subsidiary and VIEs 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% compared to 33% prior to 2008. The Company’s VIE,
XXNGC, is in the natural gas industry whose development is encouraged by the
government. According to the income tax regulation, any company engaged in the
natural gas industry enjoys a favorable tax rate. Accordingly, except for income
from SXNGE, JBLNG, SXABC, HXNGC and LBNGC which subjects to 25% PRC income tax
rate, XXNGC’s income is subject to a reduced tax rate of 15%.  A
reconciliation of tax at the United States federal statutory rate to the
provision for income tax recorded in the financial statements is as
follows:





For the three months ended
                  
                  
                  For the six months endedJune 30,
                  
                  
                  June 30,2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008(Unaudited)
                  
                  
                  (Unaudited)
                  
                  
                  (Unaudited)
                  
                  
                  (Unaudited)Tax
      provision (credit) at statutory rate
                  
                  
                  34
                  %
                  
                  
                  34
                  %
                  
                  
                  34
                  %
                  
                  
                  34
                  %Foreign
      tax rate difference
                  
                  
                  (9
                  )%
                  
                  
                  (9
                  )%
                  
                  
                  (9
                  )%
                  
                  
                  (9
                  )%Effect
      of favorable tax rate
                  
                  
                  (9
                  )%
                  
                  
                  (10
                  )%
                  
                  
                  (9
                  )%
                  
                  
                  (10
                  )%Other
      item (1)
                  
                  
                  8
                  %
                  
                  
                  5
                  %
                  
                  
                  5
                  %
                  
                  
                  5
                  %Total
      provision for income taxes
                  
                  
                  24
                  %
                  
                  
                  20
                  %
                  
                  
                  21
                  %
                  
                  
                  20
                  %


11


(1)The
8% represents $2,198,394 in expenses incurred by CHNG are not deductible in PRC
for the three months ended June 30, 2009. The 5% represents $1,573,125 expenses
incurred by CHNG that are not deductible in PRC for the three months ended June
30, 2008. The 5% represents $3,124,589 in expenses incurred by CHNG that are not
deductible in PRC for the six months ended June 30, 2009. The 5% represents
$2,578,448 expenses incurred by CHNG that are not deductible in PRC for the six
months ended June 30, 2008.





The
estimated tax savings for the three months ended June 30, 2009 and 2008,
amounted to approximately $721,445 and $531,372, respectively. The net effect on
earnings per share, had the income tax been applied, would decrease basic and
diluted earnings per share for the three months ended June 30, 2009 and 2008,
from $0.26 to $0.21 and $0.24 to $0.20, respectively.





The
estimated tax savings for the six months ended June 30, 2009 and 2008, amounted
to approximately $1,231,776 and $933,423, respectively. The net effect on
earnings per share, had the income tax been applied, would decrease basic and
diluted earnings per share for the six months ended June 30, 2009 and 2008, from
$0.55 to $0.47 and $0.43 to $0.37, respectively.





China
Natural Gas, Inc. was incorporated in the United States and has incurred net
operating loss for income tax purpose for the period ended June 30, 2009. The
estimated net operating loss carry forwards for United States income tax
purposes amounted to $1,913,731 and $1,657,473 as of June 30, 2009 and December
31, 2008, respectively, which may be available to reduce future years' taxable
income. These carry forwards will expire, if not utilized, beginning in 2027
through 2029. 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 United States income tax purposes. Accordingly, the
Company has provided a 100% valuation allowance at June 30, 2009. Management
reviews this valuation allowance periodically and makes adjustments as
warranted. The valuation allowances were as follow:





Six months ended
                    
                    
                    Year endedJune 30, 2009
                    
                    
                    December 31, 2008Valuation
      allowance
                    
                    (Unaudited)Balance,
      beginning of period
                    
                    $
                    563,541
                    
                    
                    $
                    322,614Increase
                    
                    
                    87,128
                    
                    
                    
                    240,927Balance,
      end of period
                    
                    $
                    650,669
                    
                    
                    $
                    563,541





The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $26,324,000 as of June 30, 2009, 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 we concluded that such earnings will be remitted in the
future.





Value added
tax





Sales
revenue represents the invoiced value of goods, net of a value-added tax
(“VAT”). All of the Company’s variable interest entity XXNGC’s products that are
sold in the PRC are subject to a Chinese value-added tax at a rate of 13% of the
gross sales price. This VAT may be offset by VAT paid by the XXNGC on raw
materials and other materials included in the cost of producing their finished
product. XXNGC recorded VAT payable and VAT receivable net of payments in the
financial statements. The VAT tax return is filed offsetting the payables
against the receivables.


12


All
revenues from SXABC are subject to a Chinese VAT at a rate of 6%. This VAT
cannot offset with VAT paid for materials included in the cost of
revenues.





Basic and Diluted Earnings
Per Share




Earnings
per share is calculated in accordance with the SFAS 128, “Earnings per share”.
Basic net earnings per share is based upon the weighted average number of common
shares outstanding. Diluted net earnings per share is based on the assumption
that all dilutive convertible shares and stock options were converted or
exercised.  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.





All share
and per share amounts used in the Company's consolidated financial statements
and notes thereto have been retroactively restated to reflect the 1-for-2
reverse stock split, which were effective on April 28, 2009.





Reclassifications





Certain
prior period amounts have been reclassified to conform to current period’s
presentation. These reclassifications had no material effect on net income or
cash flows as previously reported.





Recently issued accounting
pronouncements





In
January 2009, the FASB issued FSP EITF 99-20-1, “Amendments to the Impairment
Guidance of EITF Issue No. 99-20, “Recognition of Interest Income and Impairment
on Purchased and Retained Beneficial Interests in Securitized Financial Assets.”
FSP EITF 99-20-1 changes the impairment model included within EITF 99-20 to be
more consistent with the impairment model of SFAS No. 115. FSP EITF 99-20-1
achieves this by amending the impairment model in EITF 99-20 to remove its
exclusive reliance on “market participant” estimates of future cash flows used
in determining fair value. Changing the cash flows used to analyze
other-than-temporary impairment from the “market participant” view to a holder’s
estimate of whether there has been a “probable” adverse change in estimated cash
flows allows companies to apply reasonable judgment in assessing whether an
other-than-temporary impairment has occurred. The adoption of FSP EITF 99-20-1
did not have a material impact on the Company’s consolidated financial
statements.





In April
2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and
Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly” (FSP FAS 157-4). FSP FAS 157-4
amends SFAS 157 and provides additional guidance for estimating fair value in
accordance with SFAS 157 when the volume and level of activity for the asset or
liability have significantly decreased and also includes guidance on identifying
circumstances that indicate a transaction is not orderly for fair value
measurements. This FSP shall be applied prospectively with retrospective
application not permitted. The adoption of FSP FAS 157-4 did not have a material
impact on the Company’s consolidated financial statements.





In April
2009, the FASB issued FSP FAS 115-2 and FAS 124-2. This FSP amends SFAS 115,
“Accounting for Certain Investments in Debt and Equity Securities,” SFAS 124,
“Accounting for Certain Investments Held by Not-for-Profit Organizations,” and
EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on
Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held
by a Transferor in Securitized Financial Assets,” to make the
other-than-temporary impairments guidance more operational and to improve the
presentation of other-than-temporary impairments in the financial statements.
This FSP will replace the existing requirement that the entity’s management
assert it has both the intent and ability to hold an impaired debt security
until recovery with a requirement that management assert it does not have the
intent to sell the security, and it is more likely than not it will not have to
sell the security before recovery of its cost basis. This FSP provides increased
disclosure about the credit and noncredit components of impaired debt securities
that are not expected to be sold and also requires increased and more frequent
disclosures regarding expected cash flows, credit losses, and an aging of
securities with unrealized losses. Although this FSP does not result in a change
in the carrying amount of debt securities, it does require that the portion of
an other-than-temporary impairment not related to a credit loss for a
held-to-maturity security be recognized in a new category of other comprehensive
income and be amortized over the remaining life of the debt security as an
increase in the carrying value of the security. The adoption of FSP FAS 115-2
and FAS 124-2 did not have a material impact on the Company’s consolidated
financial statements.


13


In April
2009, the FASB issued FSP FAS 107-1 and APB 28-1. This FSP amends SFAS
No. 107, “Disclosures about Fair Value of Financial Instruments,” to
require disclosures about fair value of financial instruments not measured on
the balance sheet at fair value in interim financial statements as well as in
annual financial statements. Prior to this FSP, fair values for these assets and
liabilities were only disclosed annually. This FSP applies to all financial
instruments within the scope of SFAS 107 and requires all entities to disclose
the method(s) and significant assumptions used to estimate the fair value of
financial instruments. The adoption of FSP FAS 107-1 and APB 28-1 did not have a
material impact on the Company’s consolidated financial statements.





In May
2009, the FASB issued Statement of Financial Accounting Standards No. 165,
“Subsequent Events,” (FAS 165, Subsequent Events [ASC 855-10-05], which provides
guidance to establish general standards of accounting for and disclosures of
events that occur after the balance sheet date but before financial statements
are issued or are available to be issued. FAS 165 also requires entities to
disclose the date through which subsequent events were evaluated as well as the
rationale for why that date was selected. FAS 165 is effective for interim and
annual periods ending after June 15, 2009, and accordingly, the Company adopted
this Standard during the second quarter of 2009. FAS 165 requires that public
entities evaluate subsequent events through the date that the financial
statements are issued. The Company has evaluated subsequent events through the
time of filing these consolidated financial statements with the SEC on August
10, 2009.





In June
2009, the FASB issued Statement No. 166, Accounting for Transfers of Financial
Assets – an amendment of FASB No. 140 (“FAS 140”), Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities (“FAS 166”)
[ASC 860]. FAS 166 amends the criteria for a transfer of a financial asset to be
accounted for as a sale, redefines a participating interest for transfers of
portions of financial assets, eliminates the qualifying special-purpose entity
concept and provides for new disclosures. FAS 166 is effective for the Company
beginning in 2010. Should the Company’s accounts receivable securitization
programs not qualify for sale treatment under the revised rules, future
securitization transactions entered into on or after January 1, 2010 would be
classified as debt and the related cash flows would be reflected as a financing
activity. The Company is currently assessing the impact of the standard on its
securitization programs.





In June
2009, the FASB issued Statement of Financial Accounting Standards No. 167,
Amendments to FASB Interpretation No. 46(R) (“FAS 167”) [ASC 810-10], which
modifies how a company determines when an entity that is insufficiently
capitalized or is not controlled through voting (or similar rights) should be
consolidated. FAS 167 clarifies that the determination of whether a company is
required to consolidate an entity is based on, among other things, an entity’s
purpose and design and a company’s ability to direct the activities of the
entity that most significantly impact the entity’s economic performance. FAS 167
requires an ongoing reassessment of whether a company is the primary beneficiary
of a variable interest entity. FAS 167 also requires additional disclosures
about a company’s involvement in variable interest entities and any significant
changes in risk exposure due to that involvement. FAS 167 is effective for
fiscal years beginning after November 15, 2009. The Company is currently
assessing the impact of the standard on its securitization
programs.





In June
2009, the FASB issued Statement of Financial Accounting Standards No. 168, The
FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted
Accounting Principles a Replacement of FASB Statement No. 162 (“FAS 168”). This
Standard establishes the FASB Accounting Standards CodificationTM (the
“Codification”) as the source of authoritative accounting principles recognized
by the FASB to be applied by nongovernmental entities in the preparation of
financial statements in conformity with U.S. GAAP. The Codification does not
change current U.S. GAAP, but is intended to simplify user access to all
authoritative U.S. GAAP by providing all the authoritative literature related to
a particular topic in one place. The Codification is effective for interim and
annual periods ending after September 15, 2009, and as of the effective date,
all existing accounting standard documents will be superseded. The Codification
is effective for the Company in the third quarter of 2009, and accordingly, the
Company’s Quarterly Report on Form 10-Q for the quarter ending September 30,
2009 and all subsequent public filings will reference the Codification as the
sole source of authoritative literature.


14





Note
3 – Other Assets





Other
assets consisted of the following:





June 30,
                  
                  
                  December 31,2009
                  
                  
                  2008UnauditedPrepaid
      rent – natural gas stations
                  
                  $
                  376,986
                  
                  
                  $
                  272,635Prepayment
      for acquiring land use right
                  
                  
                  1,421,050
                  
                  
                  
                  1,060,675Advances
      on purchasing equipment and construction in progress
                  
                  
                  6,527,098
                  
                  
                  
                  6,427,974Refundable
      security deposits
                  
                  
                  530,063
                  
                  
                  
                  981,083Others
                  
                  
                  165,870
                  
                  
                  
                  101,695Total
                  
                  $
                  9,021,067
                  
                  
                  $
                  8,844,062





All land
in the PRC is government owned.  However, the government grants users
land use rights.  As of June 30, 2009 and December 31, 2008, the
Company prepaid $1,421,050 (unaudited) and $1,060,675, respectively, to the PRC
local government to purchase land use rights. The Company is in the process of
negotiating the final purchase price with the local government and the land use
rights have not yet been granted to the Company. Therefore, the Company did not
amortize the prepaid land use rights.





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





Refundable
security deposits are monies deposited with one of the Company’s major vendors
and gas station landlord.  These amounts will be returned to the
Company if they terminate the business relationship or at the end of the
lease.





Note
4 – Senior Notes Payable





On
December 30, 2007, the Company entered into a Securities Purchase Agreement with
Abax Lotus Ltd. (the “Investor”). The Purchase Agreement was subsequently
amended on January 29, 2008, pursuant to which the Company (i) agreed to issue
5.00% Guaranteed Senior Notes due 2014 (the “Senior Notes”) of approximately
$20,000,000, (ii) agreed to issue to the Investor Senior Notes in aggregate
principal amount of approximately $20,000,000 on or before March 3, 2008 subject
to the Company meeting certain closing conditions, (iii) granted the Investor an
option to purchase up to approximately $10,000,000 in principal amount of its
Senior Notes and (iv) agreed to issue to the Investor seven-year warrants
exercisable for up to 1,450,000 shares of the Company’s common stock (the
“Warrants”) at an initial exercise price equal to $14.7304 per share, subject to
certain adjustments, which adjusted to $7.3652 on January 29,
2009.  On January 29, 2008, the Company issued $20,000,000 Senior
Notes and 1,450,000 warrants pursuant to the Purchase Agreement. On March 3,
2008, the Investor exercised its first option for an additional $20,000,000 of
Senior Notes. On March 10, 2008, the Company issued $20,000,000 in additional
Senior Notes resulting in total Senior Notes of $40,000,000.





At the
closing, the Company entered into:





·
            An
      indenture for the 5.00% Guaranteed Senior Notes due
  2014;


·
            An
      investor rights agreement;


·
            A
      registration rights agreement covering the shares of common stock issuable
      upon exercise of the warrants;


·
            An
      information rights agreement that grants to the Investor, subject to
      applicable law, the right to receive certain information regarding the
      Company;


·
            A
      share-pledge agreement whereby the Company granted to the Collateral Agent
      (on behalf of the holders of the Senior Notes) a pledge on 65% of the
      Company’s equity interest in Shaanxi Xilan Natural Gas Equipment Co.,
      Ltd., a PRC corporation and wholly-owned subsidiary of the Company;
      and


15


·
            An
      account pledge and security agreement whereby the Company granted to the
      Collateral Agent a security interest in the account where the proceeds
      from the Senior Notes are
deposited.





In
addition, Qinan Ji, Chief Executive Officer and Chairman of the Board of the
Company, executed a non-compete agreement for the benefit of the
Investor.





The
Senior Notes were issued pursuant to an indenture between the Company and DB
Trustees (Hong Kong) Limited, as trustee, at the closing. The Senior Notes will
mature on January 30, 2014 and will initially bear interest at the stated
interest rate of 5.00% per annum, subject to an increase in the event of certain
circumstances. The Company is required to make mandatory prepayments on the
Senior Notes on the following dates and in the following amounts, expressed as a
percentage of the aggregate principal amount of Notes that will be outstanding
on the first such payment date:




Date
                      
                      Prepayment PercentageJuly
      30, 2011
                      
                      
                      8.3333
                      %January
      30, 2012
                      
                      
                      8.3333
                      %July
      30, 2012
                      
                      
                      16.6667
                      %January
      30, 2013
                      
                      
                      16.6667
                      %July
      30, 2013
                      
                      
                      25.0000
                      %





During
the twelve month period commencing January 30 of the years set forth below, the
Company may redeem the Senior Notes at the following principal
amount:




Year
                    
                    Principal2009
                    
                    
                    43,200,0002010
                    
                    
                    42,400,0002011
                    
                    
                    41,600,0002012
                    
                    
                    40,800,0002013
      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
indenture requires the Company to pay additional interest at the rate of 3.0%
per annum of the Senior Notes if the Company has not obtained a listing of its
common stock on the Nasdaq Global Market, the Nasdaq Capital Market or the New
York Stock Exchange by January 29, 2009 and maintained such listing continuously
thereafter as long as the Senior Notes are outstanding. As of January 29, 2009,
the Company has not obtained a listing of its common stock on the market stated
in the agreement. However, the Company obtained a three-month waiver from AMAX
for the additional interest payment. The waiver gives the Company three more
months until April 28, 2009 to achieve the uplisting status. By the end of the
extended period, if the Company can’t get its stock uplisted, the Company would
try to get another waiver or the Company will have to pay an additional interest
at the rate of 3.0% starting January 30, 2009. The Company wasn’t approved to be
listed on Nasdaq market until May 2009. As of the reporting date, the Company
didn’t obtain another formal waiver but reached an agreement with the lender
that the three months interest can be waived with contingency
condition.  For the three months and six months ended June 30, 2009,
the Company has recognized the additional interest payment amounted to $203,334
and $406,667, respectively.  As of June 30, 2009, none of the payment
has been paid as the Company is in the processing of settling this
payment.





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.


16


The
Company also entered into an investor rights agreement, pursuant to which, as
long as an investor holds at least 10% of the aggregate principal amount of the
Senior Notes issued and outstanding or at least 3% of the Company’s issued and
outstanding common stock pursuant to the warrants on an as-exercised basis
(“Minimum Holding”), the Company has agreed not to undertake certain corporate
actions without prior Investor approval. In addition, so long as an Investor
owns the Minimum Holding, such Investor shall have a right of first refusal for
future debt securities offerings by the Company and the Company is subject to
certain transfer restrictions on its securities and certain other
properties.




From the
Closing Date and as long as the Investor continues to hold more than 10% of the
outstanding shares of common stock on an as-converted, fully-diluted basis, the
Investor shall be entitled to appoint one of the Company’s board of directors
(the “Investor Director”). The Investor Director shall be entitled to serve on
each committee of the board, except that, the Investor Director shall not serve
on the audit committee unless it is an independent director. Mr. Ji has agreed
to vote his shares for the election of the Investor Director.




The
Company was required to prepare and file a registration statement covering the
sales of all of the shares of common stock issuable upon exercise of the
warrants or incur additional interest of 1% on the Notes.  The
Company’s registration statement was declared effective on May 6, 2008;
therefore, no penalties were incurred.





In
connection with the issuance of the Securities Purchase Agreement, the Company
paid $2,122,509 in debt issuance costs which is being amortized over the life of
the Senior Notes.  For the three months ended June 30, 2009 and
2008, the Company amortized $13,857 and $66,322 of the aforesaid issuance costs,
net of capitalized interest. For the six months ended June 30, 2009 and
2008, the Company amortized $52,435 and $122,592 of the aforesaid issuance
costs, net of capitalized interest.





In
connection with the Securities Purchase Agreement, the Company agreed to issue
to the Investor seven-year warrants exercisable for up to 1,450,000 shares of
the Company’s common stock at an initial exercise price equal to $14.7304 per
share, subject to certain adjustments. The exercise price of the Warrants is
adjusted on the first anniversary of issuance and thereafter, at every six month
anniversary beginning in the fiscal year 2009 if the volume weighted average
price, or VWAP, (as defined therein) for the 15 trading days prior to the
applicable reset date is less than the then applicable exercise price, in which
case the exercise price shall be adjusted downward to the then current VWAP;
provided, however, that in no event shall the exercise price be adjusted below
$7.3652 per share. The exercise price was adjusted to $7.3652 on January 29,
2009. No further adjustments of the exercise price will be required (as that is
the floor price).





The
warrants granted to the Investor on January 29, 2008 are considered derivative
instruments that need to be bifurcated from the original security.  If
the Warrants have not been exercised within the seven year period, then the
Investor can have the Company purchase the 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 June 30, 2009 and 2008, the Company amortized $46,484 and $312,810 of
the aforesaid discounts, net of capitalized interest. For the six months ended
June 30, 2009 and 2008, the Company amortized $217,196 and $459,473 of the
aforesaid discounts, net of capitalized interest.





The
warrants have been determined to be derivative liabilities instruments because
there is a required redemption requirement if the holder does not exercise the
Warrants.  However, the warrants are not required to be valued at fair
value, rather, to be at its undiscounted redemption amount of $17.5 million
according to FAS 150.





Note
5 – Warrants





Following
is a summary of the warrant activity:





Warrants
                    Outstanding
                  
                  
                  Weighted Average
                    Exercise Price
                  
                  
                  Aggregate
                    Intrinsic ValueOutstanding,
      December 31, 2007
                  
                  
                  544,242
                  
                  
                  $
                  13.10
                  
                  
                  
                  376,977Granted
                  
                  
                  1,450,000
                  
                  
                  $
                  14.74
                  
                  
                  
                  -Forfeited
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Outstanding,
      December 31, 2008
                  
                  
                  1,994,242
                  
                  
                  $
                  14.28
                  
                  
                  
                  -Granted
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  (160,588
                  )
                  
                  $
                  7.20
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Outstanding,
      June 30, 2009 (Unaudited)
                  
                  
                  1,833,654
                  
                  
                  $
                  8.93
                  
                  
                  
                  2,871,569


17


Following
is a summary of the status of warrants outstanding at June 30, 2009
(Unaudited):





Outstanding WarrantsExercise Price
                    
                    Number
                    
                    
                    Average
                      Remaining
                      Contractual
                      Life$7.37
                    
                    
                    1,450,000
                    
                    
                    
                    5.58$14.86
                    
                    
                    383,654
                    
                    
                    
                    3.09$8.93
                    
                    
                    1,833,654
                    
                    
                    
                    5.06





Note
6 – Defined Contribution Plan





The
Company is required to participate in a defined contribution plan operated by
the local municipal government in accordance with Chinese law and
regulations.  The Company contributes 100RMB per employee per month to
the plan. Starting from 2008, no minimum contribution is required but the
maximum contribution cannot be more than 14% of the current salary expense. The
total contribution for the above plan was $33,891 and $0 for the three months
ended June 30, 2009 and 2008, respectively.  The total contribution
for the above plan was $81,079 and $0 for the six months ended June 30, 2009 and
2008, respectively.





Note
7 – Statutory Reserve





As
stipulated by the Company Law of the People’s Republic of China (PRC) as
applicable to Chinese 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;





iii.
            Allocations
      to the discretionary surplus reserve, if approved in the shareholders’
      general meeting.





As of
June 30, 2009, the remaining reserve needed to fulfill the 50% registered
capital requirement totaled $53,831,675.





Note
8 – Accounting for stock-based compensation





1)
Options from CEO to pay for certain Company’s legal expenses





On
September 22, 2007, Mr. Qinan Ji, chairman and shareholder of the Company,
transferred 50,000 of his personally-owned options to the Company’s attorney to
cover certain Company legal expenses. 30% of the options vested on September 22,
2008, 30% vest on September 22, 2009, and the remaining 40% vest on September
22, 2010.  Upon termination of service to the Company, the attorney is
required to return all unvested options.  These options expire June 1,
2012.





The
Company used the Black-Sholes Option Pricing Model to value the options at the
time they were issued, based on the stock price on its grant date, the stated
exercise prices and expiration dates of the instruments and using a risk-free
rate of 4.10%. The estimated life is based on one half of the sum of the vesting
period and the contractual life of the option. This is the same as assuming that
the options are exercised at the mid-point between the vesting date and
expiration date. $14,842 and $38,896 of compensation expense was recorded during
the three months ended June 30, 2009 and 2008, respectively. $29,685 and $38,896
of compensation expense were recorded during the six months ended June 30, 2009
and 2008, respectively.


18





As of
June 30, 2009, approximately $102,874 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 1.25 years.





2) 2009
stock option plan





On March
11, 2009, the board of directors approved by written consent the Company’s stock
option plan for its employees, directors and consultants. Pursuant to the plan,
the total stock option pool will equal to 10% of the Company’s total shares
outstanding as of March 11, 2009. Among the option pool approved, 4% shall be
awarded in 2009 and another 4% shall be awarded in 2010, and 2% reserved for
future awards. For the 2009 stock option award, the CEO and CFO were granted
total options of 1% and 0.6% of the common shares outstanding respectively, 50%
as Non-qualified Stock Options (NSO) and 50% as Incentive Stock Awards (ISA),
for a vesting period of four years.  As Richard Wu has resigned as
CFO, the Company granted to his successor, Veronica Chen, options to purchase
75,000 shares (post-split) of the Company’s common stock, representing
approximately 0.5% of the Company’s outstanding shares as of March 11, 2009,
with the same terms and conditions as specified in the stock options
plan.  5,000 option shares per year will be granted to each
non-executive board member and 6,000 option shares per year granted to the Audit
Committee Chairman. Other senior management and employees will be granted total
options of 2.11% of the Company’s common shares. On April 1, 2009 and May 1,
2009, the Company issued 243,850 and 75,000 stock options, respectively,
pursuant to the Company's 2009 employee stock option and stock award
plan.  The strike price for the options was $4.90 per share. The stock
option has a term of six years and vests evenly over four years starting one
year from the issuance date on an annually basis.





The
Company used the Black-Sholes Option Pricing Model to value the options at the
time they were issued, based on the stock price on its grant date, the stated
exercise prices and expiration dates of the instruments and using risk-free
rates. The estimated life is based on one half of the sum of the vesting period
and the contractual life of the option. This is the same as assuming that the
options are exercised at the mid-point between the vesting date and expiration
date. $71,073 of compensation expense was recorded during three months and six
months ended June 30, 2009.





As of
June 30, 2009, approximately $1,066,094 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 3.75 years.


Following
is a summary of the Stock option activity:





Options
                    Outstanding
                  
                  
                  Weighted Average
                    Exercise Price
                  
                  
                  Aggregate
                    Intrinsic ValueOutstanding,
      December 31, 2008
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Granted
                  
                  
                  318,850
                  
                  
                  $
                  4.9
                  
                  
                  
                  95,655Forfeited
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Outstanding,
      June 30, 2009 (Unaudited)
                  
                  
                  318,850
                  
                  
                  $
                  4.9
                  
                  
                  
                  1,785,560





Following
is a summary of the status of stock options outstanding at June 30, 2009
(unaudited):





Outstanding
      Options
                          
                          
                          Exercisable
      OptionsExercise
                            Price
                          
                          Number
                          
                          
                          Average
                            Remaining
                            Contractual
                            Life
                          
                          
                          Exercise
                            Price
                          
                          
                          Number
                          
                          
                          Average
                            Remaining
                            Contractual
                            Life$4.90
                          
                          
                          243,850
                          
                          
                          
                          5.75
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -$4.90
                          
                          
                          75,000
                          
                          
                          
                          5.84
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -


19


Note
9 – Earnings per Share





Earnings
per share for the periods ended June 30, 2009 and 2008 is determined by dividing
net income for the periods by the weighted average number of both basic and
diluted shares of common stock and common stock equivalents outstanding. The
following is an analysis of the differences between basic and diluted earnings
per common share in accordance with Statement of Financial Accounting Standards
No. 128, “Earnings per Share.”





The
following demonstrates the calculation for earnings per share for the periods
ended June 30, 2009 and 2008:


For
      the three months ended
                      
                      
                      For
      the six months endedJune 30,
                      
                      
                      June 30,Basic
      earning per share
                      
                      2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008(Unaudited)
                      
                      
                      (Unaudited)
                      
                      
                      (Unaudited)
                      
                      
                      (Unaudited)Net
      income
                      
                      
                      3,862,756
                      
                      
                      
                      3,512,892
                      
                      
                      
                      8,064,379
                      
                      
                      
                      6,321,463Weighted
      shares outstanding-Basic
                      
                      
                      14,600,154
                      
                      
                      
                      14,600,154
                      
                      
                      
                      14,600,154
                      
                      
                      
                      14,600,154Earnings
      per share-Basic
                      
                      $
                      0.26
                      
                      
                      $
                      0.24
                      
                      
                      $
                      0.55
                      
                      
                      $
                      0.43Diluted
      earning per shareNet
      income
                      
                      
                      3,862,756
                      
                      
                      
                      3,512,892
                      
                      
                      
                      8,064,379
                      
                      
                      
                      6,321,463Weighted
      shares outstanding-Basic
                      
                      
                      14,600,154
                      
                      
                      
                      14,600,154
                      
                      
                      
                      14,600,154
                      
                      
                      
                      14,600,154Effect
      of diluted securities-Warrants
                      
                      
                      126,493
                      
                      
                      
                      61,594
                      
                      
                      
                      -
                      
                      
                      
                      64,713Weighted
      shares outstanding-Diluted
                      
                      
                      14,726,647
                      
                      
                      
                      14,661,748
                      
                      
                      
                      14,600,154
                      
                      
                      
                      14,664,867Earnings
      per share –Diluted
                      
                      $
                      0.26
                      
                      
                      $
                      0.24
                      
                      
                      $
                      0.55
                      
                      
                      $
                      0.43





At June
30, 2009 and 2008, the Company had outstanding warrants of 1,833,654 and
1,994,242, respectively.  For the three months ended June 30, 2009,
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 126,493; 383,654 outstanding warrants were excluded from the diluted earnings
per share calculation as they are anti-dilutive. For the three months ended June
30, 2008, the average stock price was greater than the exercise prices of the
160,588 warrants which resulted in additional weighted average common stock
equivalents of 61,594; 1,833,654 outstanding warrants were excluded from the
diluted earnings per share calculation as they are anti-dilutive. For the six
months ended June 30, 2009, all 1,833,654 outstanding warrants were excluded
from the diluted earnings per share calculation as they are anti-dilutive. For
the six months ended June 30, 2008, the average stock price was greater than the
exercise prices of the 160,588 warrants which resulted in additional weighted
average common stock equivalents of 64,713; 1,833,654 outstanding warrants were
excluded from the diluted earnings per share calculation as they are
anti-dilutive.




20


Note
10 – Current Vulnerability Due to Certain Concentrations





Concentration
of natural gas vendors:


For
      the three months ended
                
                
                For
      the six months endedJune 30,
                
                
                June 30,2009
                
                
                2008
                
                
                2009
                
                
                2008(Unaudited)
                
                
                (Unaudited)
                
                
                (Unaudited)
                
                
                (Unaudited)Numbers
      of natural gas vendors
                
                
                4
                
                
                
                4
                
                
                
                4
                
                
                
                4Percentage
      of total natural gas purchases
                
                
                97
                %
                
                
                99
                %
                
                
                90
                %
                
                
                99
                %





As of
June 30, 2009 and December 31, 2008, the Company has $117,200 and $206,811,
respectively, payable due to its major suppliers.





The
Company maintains long-term natural gas minimum purchase agreements with one of
its vendors as of June 30, 2009. There are no minimum purchase requirements by
the Company.  Contracts are renewed on an annual basis. The Company’s
management reports that it does not expect any issues or difficulty in
continuing to renew the supply contracts with these vendors going forward. Price
points for natural gas are strictly controlled by the government and have
remained stable over the past three years.





The
Company's operations are carried out in the People’s Republic of China.
Accordingly, the Company's business, financial condition and results of
operations may be influenced by the political, economic and legal environments
in the People’s Republic of China, by the general state of the People’s Republic
of China‘s economy. The Company's business may be influenced by changes in
governmental policies with   respect to laws and regulations,
anti-inflationary measures, currency conversion and remittance abroad, and rates
and methods of taxation, among other things.





Note
11 – Commitments and Contingencies





(a)  Lease
Commitments





The
Company recognizes lease expense on a straight-line basis over the term of the
lease in accordance to FAS 13, “Accounting for leases.” The Company entered
into a series of long-term lease agreements with outside parties to lease land
use rights to the self-built Natural Gas filing stations located in the PRC. The
agreements have terms ranging from 10 to 30 years. The Company makes annual
prepayments for most lease agreements.  The Company also entered into
two office leases in Xi’an, PRC and New York, NY.  The minimum future
payment for leasing land use rights and offices is as follows:





Year
      ending December 31, 2009
                  
                  $
                  430,734Year
      ending December 31, 2010
                  
                  
                  1,458,518Year
      ending December 31, 2011
                  
                  
                  1,577,171Year
      ending December 31, 2012
                  
                  
                  1,339,207Year
      ending December 31, 2013
                  
                  
                  1,280,490Thereafter
                  
                  
                  21,923,925Total
                  
                  $
                  28,010,045





For the
three months ended June 30, 2009 and 2008, the land use right and office lease
expenses were $406,016 and $ 310,698, respectively. For the six months ended
June 30, 2009 and 2008, the land use right and office lease expenses were
$798,097 and $373,945 respectively.


21


(b)
Property and Equipment





In
January 2008, the Company entered into a contract with Chemtex International
Inc. to purchase equipment supply for the LNG plant and storage tank located in
Jingbian County, Shannxi Province China, in the total amount of $13,700,000. On
May 16, 2008, JBLNG entered into an agreement with Hebei Tongchan Import and
Export Co. Ltd. (Hebei) and agreed that Hebei will act as the trade agency for
JBLNG. On June 16, 2008, the Company entered into an equipment supply contract
with Chemtex International Inc. to supply imported equipment for a LNG plant and
a storage tank to be built by Jingbian Xilan LNG Co. Ltd. As of June 30, 2009,
the Company advanced $6,299,500 to the trade agency and the future commitment
for equipment is $7,400,500.





(c)
Natural Gas Purchase Commitments





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





(d) Legal
Proceedings





A former
member of the board of directors filed a lawsuit against the Company in the 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 the
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 options 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.  Regardless of the outcome of the appeal, the Company believes that
any liability it would incur will not have a materially adverse effect on its
financial condition or its results of operations, and, accordingly, this matter
has not been reflected on the Company's consolidated financial
statements.





Note
12 – Subsequent Events





On July
22, 2009, China Natural Gas, Inc., through its variable interest entity, Xi’an
Xilan Natural Gas Co., Ltd. (“Xi’an Xilan”), entered into a joint venture
agreement (“Joint Venture Agreement”) with China National Petroleum Corporation
Kunlun Natural Gas Co., Ltd. (“Kunlun”). Pursuant to the Joint Venture
Agreement, Xi’an Xilan will form a Joint Venture Company with Kunlun (the “Joint
Venture Company”) to construct and operate compressed natural gas (“CNG”)
stations, conduct sales of CNG, convert gasoline fueled vehicles to hybrid
(natural gas/gasoline) powered vehicles and other related technical services in
Henan province, China.





The Joint
Venture Company will have an initial registered capital of RMB 50,000,000
(approximately US $7,350,000). Kunlun will contribute RMB 25,500,000 in cash,
representing 51% of the Joint Venture Company’s total registered capital, upon
the approval of the governing officers of Kunlun.





Xi’an
Xilan will contribute RMB 24,500,000, representing 49% of the Joint Venture
Company’s total registered capital, in two installments. The first installment
will be RMB 10,000,000 in cash and the second installment of RMB 14,500,000 will
be either cash, property (currently expected to be a fleet of tankers consisting
of two locomotives and four tanks)or a combination of cash and
property.





Both
parties will share the management responsibilities of the operations of the
Joint Venture Company. The Joint Venture Company shall have a term of 20 years
commencing on August 1, 2009 and terminating on July 31, 2029.




22


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





CAUTIONARY
STATEMENT





FORWARD-LOOKING
STATEMENT





The
information in this report contains forward-looking statements. All statements
other than statements of historical fact made in this report are forward
looking. In particular, the statements herein regarding industry prospects and
future results of operations or financial position are forward-looking
statements. These forward-looking statements can be identified by the use of
words such as "believes," "estimates," "could," "possibly," "probably,"
anticipates," "projects," "expects," "may," "will," or "should" or other
variations or similar words. No assurances can be given that the future results
anticipated by the forward-looking statements will be achieved. Forward-looking
statements reflect management's current expectations and are inherently
uncertain. Our actual results may differ significantly from management's
expectations.





The
following discussion and analysis should be read in conjunction with our
financial statements, included herewith. This discussion should not be construed
to imply that the results discussed herein will necessarily continue into the
future, or that any conclusion reached herein will necessarily be indicative of
actual operating results in the future. Such discussion represents only the best
present assessment of our management.





Overview





We are a
distributor of compressed natural gas ("CNG") in China, which we primarily
distribute through our Company-owned CNG fueling stations. As of June 30, 2009,
we operated 23 CNG fueling stations in Shaanxi province and 12 CNG fueling
stations in Henan province. We own our CNG fueling stations while we lease the
land upon which our CNG fueling stations operate. For the three and six months
ended June 30, 2009, we sold CNG of 41,152,513 and 80,446,633 cubic meters
respectively through our fueling stations, compared to 37,304,556 and 67,844,028
cubic meters for the three and six months ended June 30, 2008. We also
transport, distribute and sell piped natural gas to residential and commercial
customers in the Xi’an area, including Lantian County, and the districts of
Lintong and Baqiao, in Shaanxi province through a high pressure pipeline network
of approximately 120 kilometers.





We
operate four main business lines:





·
            Distribution
      and sale of compressed natural gas through Company-owned CNG fueling
      stations for hybrid (natural gas/gasoline) powered vehicles (35 stations
      as of June 30, 2009);





·
            Installation,
      distribution and sale of piped natural gas to residential and commercial
      customers through Company-owned pipelines. We distributed and sold piped
      natural gas to 103,343 residential customers as of June 30,
      2009;





·
            Distribution
      and sale of gasoline through Company-owned CNG fueling stations for
      gasoline and hybrid (natural gas/gasoline) powered vehicles (8 of our CNG
      fueling stations sold gasoline as of June 30, 2009);
  and





·
            Conversion
      of gasoline-fueled vehicles to hybrid (natural gas/gasoline) powered
      vehicles at our auto conversion
sites.




We buy
all of the natural gas that we sell and distribute to our customers. We do not
mine or produce any of our own natural gas and have no plans to do so during the
next 12 months. We currently sell our natural gas in two forms: (i) CNG and (ii)
piped natural gas.





On
October 24, 2006, our variable interest entity, Xi'an Xilan Natural Gas Co.,
Ltd. ("XXNGC"), formed a wholly-owned subsidiary, Shaanxi Jingbian Liquefied
Natural Gas Co., Ltd. ("SJLNG"), for the purpose of constructing a liquefied
natural gas ("LNG") facility to be located in Jingbian, Shaanxi province. We
plan to invest approximately $45 million to construct this facility, a portion
of which was funded through the sale of senior notes to Abax Lotus Ltd., and the
remainder of which will be funded by our cash flows from operations. The LNG
plant is under construction and is expected to be completed and fully
operational by the end of 2009. Once completed, the plant is expected to have a
LNG processing capacity of 500,000 cubic meters per day, or approximately 150
million cubic meters on an annual basis.


23


We had
total revenues of $20,742,520 and $16,890,486 for the three months ended June
30, 2009 and 2008 respectively and revenues of $39,270,186 and $30,916,160 for
the six months ended June 30, 2009 and 2008, respectively. We had net income of
$3,862,756 and $3,512,892 for the three months ended June 30, 2009 and 2008
respectively and net income of $8,064,379 and $6,321,463 for the six months
ended June 30, 2009 and 2008 respectively.





Factors
Affecting Our Results of Operations





Significant
factors affecting our results of operations are:





Successful
expansion of our CNG fueling station business in our target markets. Our
revenue increased by 22.8% during the three months ended June 30, 2009 from the
three months ended June 30, 2008 and by 27.0% during the six months ended June
30, 2009 from the six months the June 30, 2008 largely because of the addition
of 6 new fueling stations added since the second quarter of 2008, as well as the
increase of pipeline natural gas customers. As of June 30, 2009, we operated 35
CNG fueling stations in total and, in Shaanxi alone, we operated 23 CNG
fueling stations. We believe we are the largest provider of CNG fueling stations
in Xi’an, one of our core target markets for CNG. As of June 30, 2009, we
operated 12 CNG fueling stations in Henan province, another of our core target
markets. The successful expansion of our CNG fueling station business in Xi’an
and Henan province has been a significant factor driving our revenue growth and
results of operations for the period reviewed. 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 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 (“NDRC”), and the local state price bureaus
who have the discretion to set natural gas prices within the boundaries set by
the PRC central government.  In addition, natural gas procurement and
sale prices are not uniform across China and can vary across provinces. For
example, the prices at which we procure and sell CNG and piped natural gas are
lower in Shaanxi than in Henan. 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 we expand
our natural gas business into other provinces, we expect our results of
operations to continue to be affected significantly by the regulation of natural
gas prices in the PRC.





Government
policies encouraging the adoption of cleaner burning
fuels.  Our results of operations for the periods reviewed 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 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 sale infrastructure
for natural gas in various policy pronouncements such as by officially including
CNG/gasoline hybrid vehicles in the country's "encouraged development" category.
These policies have benefited our results of operations by encouraging the
demand for our natural gas products and also by lowering our expenses. As we
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
technology.





The overall
economic growth of China’s economy.We do not export our products outside
China and our results of operations are thus substantially affected by the
growth of the industrial base, the increase in residential, commercial and
vehicular consumption and the overall economic growth of China. While's China's
economy has experienced a slowdown after the second quarter of 2007, we are
currently unable to estimate the impact of such slow down on our business; as
the impact of the decline in international trade is being offset in part through
domestic stimulus spending, expanded bank lending, increases in the speed of
regulatory approvals of new construction projects and other economic policies.
While we do not believe we have experienced reduced demand for natural gas to
date, if the economic downturn continues, our results of operations may be
negatively affected by any decrease in demand for natural gas in the second half
of 2009.


24





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 June 30, 2009. The estimated net operating loss carry forwards for
United States income tax purposes amounted to $1,913,731 and $1,657,473 as of
June 30, 2009 and December 31, 2008, respectively, which may be available to
reduce future years' taxable income. These carry forwards will expire, if not
utilized, beginning in 2027 through 2029. Our management believes that the
realization of the benefits arising from this loss appear to be uncertain due to
our Company's limited operating history and continuing losses for United States
income tax purposes. Accordingly, we have provided a 100% valuation allowance at
June 30, 2009.





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% 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 Xilan Equipment, SJLNG,
XXABC, HXNGC and LBNGC are subject to the 25% PRC income tax rate. Our effective
income tax rate for the three months ended June 30, 2009 and 2008 were
approximately 23.5% and 19.7%, respectively.





Value
Added Tax





Sales
revenue represents the invoiced value of goods, net of a value-added tax
("VAT").  All of our variable interest entity XXNGC's products that
are sold in the PRC are subject to a Chinese VAT at a rate of 13% of the gross
sales price. This VAT may be offset by VAT paid by XXNGC on raw materials and
other materials included in the cost of producing their finished products. XXNGC
records VAT payable and VAT receivable net of payments in its financial
statements. VAT tax returns are filed offsetting the payables against the
receivables.





All
revenues from XXABC are subject to a Chinese VAT at a rate of 6%. This VAT
cannot be offset with VAT paid for materials included in the cost of
revenues.





Internal
Control Over Financial Reporting





We are
subject to reporting obligations under the U.S. securities laws. The SEC,
as required by Section 404 of the Sarbanes-Oxley Act, adopted rules
requiring every public company to include a management report on such company’s
internal control over financial reporting in its annual report, which contains
management’s assessment of the effectiveness of the company’s internal control
over financial reporting. In addition, an independent registered public
accounting firm must report on our internal control over financial reporting.
Our management has concluded that our internal control over our financial
reporting is not effective as of June 30, 2009.


25


CONSOLIDATED
RESULTS OF OPERATIONS





Three
Months Ended June 30, 2009 Compared to Three Months Ended June 30,
2008





The
following table represents the consolidated operating results for the three
month period ended June 30, 2009 and 2008:





Sales
Revenues





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




June
      30,
                  2009
                
                
                June
      30,
                  2008
                
                
                Increase in dollar
                  amount
                
                
                Increase in
                  percentageNatural
      gas from fueling stations
                
                $
                15,051,319
                
                
                $
                13,181,335
                
                
                $
                1,869,984
                
                
                
                14.2
                %Natural
      gas from pipelines
                
                
                669,360
                
                
                
                613,531
                
                
                
                55,829
                
                
                
                9.1
                %Gasoline
                
                
                1,633,016
                
                
                
                1,148,097
                
                
                
                484,919
                
                
                
                42.2
                %Installation
                
                
                2,690,164
                
                
                
                1,282,400
                
                
                
                1,407,764
                
                
                
                109.8
                %Auto
      conversion
                
                
                698,661
                
                
                
                665,123
                
                
                
                33,538
                
                
                
                5.0
                %Total
                
                $
                20,742,520
                
                
                $
                16,890,486
                
                
                $
                3,852,034
                
                
                
                22.8
                %




Overal.:
Total revenue for the three months ended June 30, 2009 increased to $20,742,520
from $16,890,486 for the three months ended June 30, 2008, an increase of
$3,852,034 or 22.8%. This increase was mainly due to the addition of 6 new
fueling stations added since the second quarter of 2008, and an increase in the
number of residential and commercial pipeline customers to 103,343 as of June
30, 2009 from 91,967 as of June 30, 2008. We sold natural gas of 44,090,672
cubic meters during the three months ended June 30, 2009, compared to 39,
986,368 cubic meters during the three months ended June 30, 2008. For the
three months ended June 30, 2009, 83.7% of our revenue was generated from the
sale of natural gas and gasoline, and the other 16.3% was generated from our
installation and auto conversion services.





Natural Gas from
Fueling Stations.Natural gas revenue from our fueling stations increased
by 14.2%, or $1,869,984, to $15,051,319 during the three months ended June 30,
2009, from $13,181,335 during the three months ended June 30, 2008, and
contributed to 72.6% of our total revenue, which was the largest among our four
major business lines. The increase of natural gas revenue was mainly due to the
increase of sales volume generated from newly added fueling stations during the
2nd
and 3rd
quarters of 2008. During the three months ended June 30, 2009, we sold
compressed natural gas of 41,152,513 cubic meters, compared to 37, 304,556 cubic
meters during the three months ended June 30, 2008 through our fueling stations.
In terms of average station sales value and volume, in the three months ended
June 30, 2009, we sold approximately $430,038 and 1,175,786 cubic
meters of compressed natural gas per station, compared to approximately
$434,597 and 1,229,956 cubic meters in the three months ended June 30,
2008. The reason for the decline in per station sales was due to the
construction of main subway lines in Xi'an, which caused certain bus routes to
deviate from our stations.  Unit selling price was relatively stable
at $0.37 (RMB 2.5).





Natural Gas
from Pipelines.
 Natural gas revenue from our pipelines increased by 9.1%, or $55,829, to
$669,360 during the three months ended June 30, 2009, from $613,531 during
the three months ended June 30, 2008, and contributed to 3.2% of our total
revenue. As of June 30, 2009, the Company had 103,343 pipeline customers, an
increase of 11,376 customers comparing to as of June 30, 2008.  We
also sold 2,938,159 cubic meters of natural gas through our pipelines during the
three months ended June 30, 2009, compared to 2,681,812 cubic meters during the
three months ended June 30, 2008.




26





Gasoline.
Revenue from gasoline sales increased by 42.2%, or $484,919, to $1,633,016
during the three months ended June 30, 2009, from $1,148,097 during the three
months ended June 30, 2008, and contributed 7.9% to our total revenue. The
gasoline revenue increase was due to the sales volume increased 58% from
1,707,160 liters to 2,707,531 liters, offset by 11% decrease of unit sales price
from $0.7 (RMB 4.63) per liter in the three months ended June 30, 2008 to $0.6
(RMB 4.11) per liter in the three months ended June 30, 2009, affected by the
decrease of international oil price. The increased sales volumes was due to our
two stations, Shihua and Lantian, were in operation during the three months
ended June 30, 2009, but were inactive in 2008.





Installation
Services. Revenue from installation services increased by 109.8%, or
$1,407,764, to $ 2,690,164 during the three months ended June 30, 2009, from
$1,282,400 during the three months ended June 30, 2008, and contributed 13.0% to
our total revenue. The increase of installation sales was mainly due to the
increase of pipeline customers in the newly acquired subsidiary - Lingbao
Natural Gas, Co. since January 2009. Installation services to our top four
customers contributed to 31.3%, 22.4%, 17.7% and 11.4% of our installation
revenue for the three months ended June 30, 2009.





Auto Conversion
Services. Revenue from our auto conversion division increased by 5.0%, or
$33,538, to $698,661 during the three months ended June 30, 2009, from $665,123
during the three months ended June 30, 2008, and contributed 3.4% to our total
revenue.





Cost
of Revenue





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




June
      30, 2009
                
                
                June
      30, 2008
                
                
                Increase
      /
                  (Decrease) in dollar
                  amount
                
                
                Increase
      /
                  (Decrease) in
                  percentageNatural
      gas from fueling stations
                
                $
                7,023,175
                
                
                $
                6,783,702
                
                
                $
                239,473
                
                
                
                3.5
                %Natural
      gas from pipelines
                
                
                467,343
                
                
                
                430,767
                
                
                
                36,576
                
                
                
                8.5
                %Gasoline
                
                
                1,529,752
                
                
                
                1,054,978
                
                
                
                474,774
                
                
                
                45.0
                %Installation
                
                
                1,039,116
                
                
                
                538,970
                
                
                
                500,146
                
                
                
                92.8
                %Auto
      conversion
                
                
                404,944
                
                
                
                416,306
                
                
                
                (11,362
                )
                
                
                (2.7
                )%Total
                
                $
                10,464,330
                
                
                $
                9,224,723
                
                
                $
                1,239,607
                
                
                
                13.4
                %





Overall.
Our cost of revenue consists of the cost of natural gas and gasoline sold,
installation and other costs. Cost of natural gas and gasoline sold consists of
the cost for purchase from our suppliers. Cost of installation and other costs
include certain expenditures for the connection of customers to our pipeline
system, and the cost for converting gasoline-fueled vehicles into natural gas
hybrid vehicles.





Our cost
of revenue for the three months ended June 30, 2009 was $10,464,330, an increase
of $1,239,607, or 13.4%, from $9,224,723 for the three months ended June 30,
2008, while our revenue increased by 22.8% during the same period.





Natural Gas from
Fueling Stations.Cost of revenue of our natural gas for our fueling
stations increased by 3.5%, or $239,473, to $7,023,175 during the three months
ended June 30, 2009, as compared to $6,783,702 for the three months ended June
30, 2008. The low growth rate for cost of natural gas for our fueling stations
was primarily due to the decrease of procurement price in coal bed methane as we
obtained better term from July 2008 in Henan province that reduced our unit cost
from one of our major supplier by approximately 32%, and our overall average
unit cost was reduced by 12% during the three months ended June 30,
2009.


27





Natural Gas from
Pipelines. Cost of revenue of our natural gas sold through our pipelines
increased by 8.5%, or $36,576, to $467,343 during the three months ended June
30, 2009, as compared to $430,767 during the three months ended June 30, 2008,
which was in line with the sales growth.





Gasolin.:
Cost of our gasoline revenue increased by 45.0%, to $1,529,752 during the three
months ended June 30, 2009, from $1,054,978 for the three months ended June 30,
2008. The increase of cost of gasoline revenue was due to the increase in sales
volume, offset by the effect of the decrease of average unit cost from $0.63
(RMB 4.29) per liter during the three months ended June 30, 2008 to $0.56 (RMB
3.85) per liter during the three months ended June 30, 2009 due to the
decreasing price of the international fuel market.





Installation
Services. Cost of revenue from our installation services increased by
92.8%, or $500,146, to $1,039,116 during the three months ended June 30, 2009,
as compared to $538,970 during the three months ended June 30, 2008, as a result
of the increase of pipeline customers.





Auto Conversion
Services. Cost of our auto conversion revenue decreased by 2.7%, or
$11,362, to $404,944 during the three months ended June 30, 2009, as compared to
$416,306 during the three months ended June 30, 2008.





Gross
profit





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




June
      30, 2009
                
                
                June
      30, 2008
                
                
                Increase in
                  dollar amount
                
                
                Increase in
                  percentageNatural
      gas from fueling stations
                
                $
                8,028,144
                
                
                $
                6,397,633
                
                
                $
                1,630,511
                
                
                
                25.5
                %Natural
      gas from pipelines
                
                
                202,017
                
                
                
                182,764
                
                
                
                19,253
                
                
                
                10.5
                %Gasoline
                
                
                103,264
                
                
                
                93,119
                
                
                
                10,145
                
                
                
                10.9
                %Installation
                
                
                1,651,048
                
                
                
                743,430
                
                
                
                907,618
                
                
                
                122.1
                %Auto
      conversion
                
                
                293,717
                
                
                
                248,817
                
                
                
                44,900
                
                
                
                18.1
                %Total
                
                $
                10,278,190
                
                
                $
                7,665,763
                
                
                $
                2,612,427
                
                
                
                34.1
                %





We earned
a gross profit of $10,278,190 for the three months ended June 30, 2009, an
increase of $2,612,427 or 34.1%, compared to $7,665,763 for the three months
ended June 30, 2008. In summary, gross profit increase was mainly due to
the increased sales volume of natural gas from fueling
stations with lower unit purchase cost from our major suppliers; the
increased sales volume of pipeline natural gas with stable unit price and cost;
and the increased installation revenue from new pipeline
customers.





Gross
margin





Gross
margin for natural gas sold through our fueling stations increased from 48.5% in
the three months ended June 30, 2008 to 53.3% in the three months ended June 30,
2009, due to lower coal bed methane procurement cost. Gross margin for natural
gas sold through pipelines was 30.2% during the three months ended June 30,
2009, and increased slightly as compared to 29.8% during the three months ended
June 30, 2008. Gross margin for gasoline sales decreased from 8.1% during the
three months ended June 30, 2008 to 6.3% during the three months ended June 30,
2009, due to the decrease of gasoline retail price exceeded the decrease of
gasoline purchase cost. Gross margin for our installation and auto conversion
businesses were 61.4% and 42.0% during the three months ended June 30, 2009,
respectively, and remained flat compared to 58.0% and 37.4% during the three
months ended June 30, 2008. Due to the lower natural gas procurement cost, our
total gross margin increased from 45.4% for the three months ended June 30, 2008
to 49.6% for the three months ended June 30, 2009.


28





Operating
expenses





We
incurred operating expenses of $3,514,138 for the three months ended June 30,
2009, an increase of $905,464 or 34.7%, compared to $2,608,674 for the three
months ended June 30, 2008. Sales and marketing costs increased 48.6% from
$1,568,674 for the three months ended June 30, 2008 to $2,331,739 for the three
months ended June 30, 2009, primarily due to the $414,524 increase in
depreciation expense as well as $129,303 and $99,288 increase in leasing and
utility expense, respectively, mainly related to the acquisition of Lingbao
Natural Gas, Co. in Oct. 2008 as well as the addition of 6 new fueling stations
added since the second quarter of 2008. In addition, we also increased our
efforts to obtain new residential and commercial customers and attract customers
to our fueling stations. General and administrative expenses increased from
$1,040,000 for the three months ended June 30, 2008 to $1,182,399 for the three
months ended June 30, 2009 mainly due to increase of $275,583 in depreciation
expense and $164,725 increase in salary expense primarily reflecting the growth
of employees, the recruiting of qualified Chief Financial Officer as well as
adjustment of compensation for our Chief Executive Officer to market rate,
offset by $223,048 decrease in professional service fees. The transportation
cost per million cubic meters of natural gas during the three months ended June
30, 2009 was approximately $2,384.





Income
from Operations and Operating Margin





For the
foregoing reasons, income from operations increased by $1,706,963, or 33.8%, to
$6,764,052 for the three months ended June 30, 2009, from $5,057,089 for the
three months ended June 30, 2008.  Our operating margin for the three
months ended June 30, 2009 was 32.6%, compared to 29.9% for the three months
ended June 30, 2008.





Non-Operating
Income (Expense)





Our
non-operating expense increased by $1,033,089, or 151.6%, to $1,714,613 for the
three months ended June 30, 2009, from $681,524 for the three months ended June
30, 2008, primarily due to the recognition of $1,312,834 non-operating expense
related to change in fair value of the Company’s outstanding
warrants.





Provision
for Income Tax





Income
tax was $1,186,683 for the three months ended June 30, 2009, as compared to
$862,673 for the three months ended June 30, 2008 which is in line with the
sales growth.





Net
Income





Based on
the foregoing, net income increased to $3,862,756 for the three months ended
June 30, 2009, an increase of $349,864, or 10.0%, from $3,512,892 for the three
months ended June 30, 2008. Net margin decreased from 20.8% during the three
months ended June 30, 2008 to 18.6% during the three months ended June 30, 2009.
The reduced net margin reflects the non-operating expenses related to fair value
change of the Company’s outstanding warrants.





Six
Months Ended June 30, 2009 Compared to Six Months Ended June 30,
2008





The
following table represents the consolidated operating results for the six month
period ended June 30, 2009 and 2008:


29


Sales
Revenues





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




June
      30,
                    2009
                  
                  
                  June
      30,
                    2008
                  
                  
                  Increase in dollar
                  
                  
                  Increase in
                    PercentageNatural
      gas from fueling stations
                  
                  $
                  29,309,243
                  
                  
                  $
                  23,940,566
                  
                  
                  $
                  5,368,677
                  
                  
                  
                  22.4
                  %Natural
      gas from pipelines
                  
                  
                  1,377,255
                  
                  
                  
                  1,199,619
                  
                  
                  
                  177,636
                  
                  
                  
                  14.8
                  %Gasoline
                  
                  
                  2,807,414
                  
                  
                  
                  2,278,847
                  
                  
                  
                  528,567
                  
                  
                  
                  23.2
                  %Installation
                  
                  
                  4,604,043
                  
                  
                  
                  2,352,570
                  
                  
                  
                  2,251,473
                  
                  
                  
                  95.7
                  %Auto
      conversion
                  
                  
                  1,172,231
                  
                  
                  
                  1,144,558
                  
                  
                  
                  27,673
                  
                  
                  
                  2.4
                  %Total
                  
                  $
                  39,270,186
                  
                  
                  $
                  30,916,160
                  
                  
                  $
                  8,354,026
                  
                  
                  
                  27.0
                  %




Overall.
Total revenue for the six months ended June 30, 2009 increased to $39,270,186
from $30,916,160 for the six months ended June 30, 2008, an increase of
$8,354,026 or 27.0%. This increase was mainly due to the addition of 9 new
fueling stations added since the first quarter of 2008, and an increase in the
number of residential and commercial pipeline customers to 103,343 as of June
30, 2009 from 91,967 as of June 30, 2008. We sold natural gas of 86,373,816
cubic meters during the six months ended June 30, 2009, compared to 73,255,739
cubic meters during the six months ended June 30, 2008. For the six months
ended June 30, 2009, 85.3% of our revenue was generated from the sale of natural
gas and gasoline, and the other 14.7% was generated from our installation and
auto conversion services.





Natural Gas from
Fueling Stations.Natural gas revenue from our fueling stations increased
by 22.4%, or $5,368,677, to $29,309,243 during the six months ended June 30,
2009, from $ 23,940,566 during the six months ended June 30, 2008, and
contributed to 74.6% of our total revenue, which was the largest among our four
major business lines. The increase of natural gas revenue was mainly due to the
increase of sales volume generated from the newly added fueling stations since
the first quarter of 2008. During the six months ended June 30, 2009, we sold
compressed natural gas of 80,446,633 cubic meters, compared to 67,844,028 cubic
meters during the six months ended June 30, 2008 through our fueling stations.
In terms of average station sales value and volume, in the six months ended June
30, 2009, we sold approximately $837,407 and 2,298,475 cubic
meters of compressed natural gas per station, compared to approximately
$886,688 and 2,512,742 cubic meters in the six months ended June 30,
2008. The reason for the decline in per station sales was due to the
construction of main subway lines in Xi'an, which caused certain bus routes to
deviate from our stations.  Unit selling price remained constant at $
0.36 (RMB 2.5) per cubic meter.





Natural Gas
from Pipelines.
 Natural gas revenue from our pipelines increased by 14.8%, or $177,636, to
$1,377,255 during the six months ended June 30, 2009, from $1,199,619 during the
six months ended June 30, 2008, and contributed to 3.5% of our total revenue. As
of June 30, 2009, the Company had 103,343 pipeline customers, an increase of
11,376 customers comparing to as of June 30, 2008.  We also sold
5,927,183 cubic meters of natural gas through our pipelines during the six
months ended June 30, 2009, compared to 5,411,712 cubic meters during the six
months ended June 30, 2008.





Gasoline.
Revenue from gasoline sales increased by 23.2%, or $528,567, to $2,807,414
during the six months ended June 30, 2009, from $2,278,847 during the six months
ended June 30, 2008, and contributed 7.1% to our total revenue. The gasoline
revenue increase was due to the sales volume increased 39% from 3,507,054 liters
to 4,878,763 liters, offset by 17% decrease of unit sales price from $0.67 (RMB
4.59) per liter in the six months ended June 30, 2008 to $0.57 (RMB 3.93) per
liter in the six months ended June 30, 2009, affected by the decrease of
international fuel price since the 3rd quarter
of 2008.


30





Installation
Services. Revenue from installation services increased by 95.7%, or
$2,251,473, to $4,604,043 during the six months ended June 30, 2009, from
$2,352,570 during the six months ended June 30, 2008, and contributed 11.7% to
our total revenue. The increase of installation revenue was mainly due to the
increase of pipeline customers in the newly acquired subsidiary- Lingbao Natural
Gas, Co. since January 2009. Installation services to our top four customers
contributed to 18.4%, 13.2%, 11.0% and 6.7% of our installation revenue for the
six months ended June 30, 2009.





Auto Conversion
Services. Revenue from our auto conversion division increased by 2.4%, or
$27,673, to $1,172,231 during the six months ended June 30, 2009, from
$1,144,558 during the six months ended June 30, 2008, and contributed 3.0% to
our total revenue.





Cost of
Revenue:





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




June
      30, 2009
                            
                            
                            June
      30, 2008
                            
                            
                            Increase
      /
                              (Decrease)
       in
                              dollar
                              amount
                            
                            
                            Increase in
                              percentageNatural
      gas from fueling stations
                            
                            $
                            13,267,616
                            
                            
                            $
                            12,539,977
                            
                            
                            $
                            727,640
                            
                            
                            
                            5.8
                            %Natural
      gas from pipelines
                            
                            
                            969,831
                            
                            
                            
                            856,766
                            
                            
                            
                            113,065
                            
                            
                            
                            13.2
                            %Gasoline
                            
                            
                            2,659,809
                            
                            
                            
                            2,123,015
                            
                            
                            
                            536,974
                            
                            
                            
                            25.3
                            %Installation
                            
                            
                            1,761,979
                            
                            
                            
                            933,201
                            
                            
                            
                            828,778
                            
                            
                            
                            88.8
                            %Auto
      conversion
                            
                            
                            699,109
                            
                            
                            
                            708,962
                            
                            
                            
                            (9,853
                            )
                            
                            
                            (1.4
                            )%Total
                            
                            $
                            19,358,344
                            
                            
                            $
                            17,161,921
                            
                            
                            $
                            2,196,423
                            
                            
                            
                            12.8
                            %





Overall.
Our cost of revenue consists of the cost of natural gas and gasoline sold,
installation and other costs. Cost of natural gas and gasoline sold consists of
the cost for purchase from our suppliers. Cost of installation and other costs
include certain expenditures for the connection of customers to our pipeline
system, and the cost for converting gasoline-fueled vehicles into natural gas
hybrid vehicles.





Our cost
of revenue for the six months ended June 30, 2009 was $19,358,344, an increase
of $2,196,423, or 12.8%, from $17,161,921for the six months ended June 30, 2008,
while our revenue increased by 27.0% during the same period.





Natural Gas from
Fueling Stations.Cost of revenue of our natural gas for our fueling
stations increased by 5.8%, or $727,640, to $13,267,616 during the six months
ended June 30, 2009, as compared to $12,539,977 for the six months ended June
30, 2008. The low growth rate for cost of natural gas for our fueling stations
was primarily due to the decrease of procurement price in coal bed methane as we
obtained better term from July 2008 in Henan province that reduced our unit cost
from one of our major supplier by approximately 33%, and our overall average
unit cost reduced by 16% during the six months ended June 30, 2009.





Natural Gas from
Pipelines. Cost of revenue of our natural gas sold through our pipelines
increased by 13.2%, or $ 113,065, to $969,831 during the six months ended June
30, 2009, as compared to $856,766 during the six months ended June 30, 2008,
which was in line with the sales growth.


31


Gasoline.
Cost of our gasoline revenue increased by 25.3%, to $2,659,809 during the six
months ended June 30, 2009, from $2,123,015 for the six months ended June 30,
2008. The increase of cost of gasoline revenue was due to the increase in sales
volume, offset by the effect of the decrease of average unit cost from $0.63
(RMB 4.27) per liter during the six months ended June 30, 2008 to $0.55 (RMB
3.72) per liter during the six months ended June 30, 2009 due to the decrease
price of the international fuel market.





Installation
Services. Cost of revenue from our installation services increased by
88.8%, or $828,778, to $1,761,979 during the six months ended June 30, 2009, as
compared to $933,201 during the six months ended June 30, 2008, as a result of
the increase of pipeline customers.





Auto Conversion
Services. Cost of our auto conversion revenue decreased by 1.4%, or
$9,853, to $699,109 during the six months ended June 30, 2009, as compared to
$708,962 during the six months ended June 30, 2008.





Gross
profit





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




June
      30, 2009
                        
                        
                        June
      30, 2008
                        
                        
                        Increase in
                          dollar amount
                        
                        
                        Increase in
                          percentageNatural
      gas from filling stations
                        
                        $
                        16,041,627
                        
                        
                        $
                        11,400,589
                        
                        
                        $
                        4,641,038
                        
                        
                        
                        40.7
                        %Natural
      gas from pipelines
                        
                        
                        407,424
                        
                        
                        
                        342,853
                        
                        
                        
                        64,571
                        
                        
                        
                        18.8
                        %Gasoline
                        
                        
                        147,605
                        
                        
                        
                        155,832
                        
                        
                        
                        (8,227
                        )
                        
                        
                        (5.3
                        )%Installation
                        
                        
                        2,842,064
                        
                        
                        
                        1,419,369
                        
                        
                        
                        1,422,695
                        
                        
                        
                        100.2
                        %Auto
      conversion
                        
                        
                        473,122
                        
                        
                        
                        435,596
                        
                        
                        
                        37,526
                        
                        
                        
                        8.6
                        %Total
                        
                        $
                        19,911,842
                        
                        
                        $
                        13,754,239
                        
                        
                        $
                        6,157,603
                        
                        
                        
                        44.8
                        %





We earned
a gross profit of $19,911,842 for the six months ended June 30, 2009, an
increase of $6,157,603 or 44.8%, compared to $13,754,239 for the six months
ended June 30, 2008. In summary, gross profit increase was mainly due to
the increased sales volume of natural gas from fueling
stations with lower unit purchase cost from our major suppliers; the
increased sales volume of pipeline natural gas with stable unit price and cost;
and the increased installation revenue from new pipeline
customers.





Gross
margin





Gross
margin for natural gas sold through our fueling stations increased from 47.6% in
the six months ended June 30, 2008 to 54.7% in the six months ended June 30,
2009, due to lower coal bed methane procurement cost. Gross margin for natural
gas sold through pipelines was 29.6% during the six months ended June 30, 2009,
and increased slightly as compared to 28.6% during the six months ended June 30,
2008. Gross margin for gasoline sales decreased from 6.8% during the six months
ended June 30, 2008 to 5.3% during the six months ended June 30, 2009, due to
the decrease of gasoline retail price exceeded the decrease of gasoline purchase
cost. Gross margin for our installation and auto conversion businesses were
61.7% and 40.4% during the six months ended June 30, 2009, respectively, and
remained flat compared to 60.3% and 38.1% during the six months ended June 30,
2008. Due to the lower natural gas procurement cost, our total gross margin
increased from 44.5% for the six months ended June 30, 2008 to 50.7% for the six
months ended June 30, 2009.


32


Operating
Expenses





We
incurred operating expenses of $7,520,287 for the six months ended June 30,
2009, an increase of $2,630,674 or 53.8%, compared to $4,889,613 for the six
months ended June 30, 2008. Sales and marketing costs increased 60.0% from
$2,910,288 for the six months ended June 30, 2008 to $4,655,967 for the six
months ended June 30, 2009, primarily due to $860,816 increase in depreciation
expense as well as $436,206 and $220,088 increase in leasing and utility
expense, respectively, primarily related to the acquisition of Lingbao Natural
Gas, Co. as well as the addition of 9 new fueling stations since the first
quarter of 2008. In addition, we also increased our efforts to obtain new
residential and commercial customers and attract customers to our fueling
stations. General and administrative expenses increased from $1,979,325 for the
six months ended June 30, 2008 to $2,864,320 for the six months ended June 30,
2009 mainly due to $561,216 increase in depreciation expense and $407,229
increase in salary expense primarily reflecting the growth of employees, the
recruiting of qualified Chief Financial Officer as well as adjustment of
compensation for our Chief Executive Officer to market rate. The transportation
cost per million cubic meters of natural gas during the six months ended June
30, 2009 was approximately $2,648.





Income
from Operations and Operating Margin





For the
foregoing reasons, income from operations increased by $3,526,929, or 39.8%, to
$12,391,555 for the six months ended June 30, 2009, from $8,864,626 for the six
months ended June 30, 2008.  Our operating margin for the six months
ended June 30, 2009 was 31.6%, compared to 28.7% for the six months ended June
30, 2008.





Non-Operating
Income (Expense)





Our
non-operating expense increased by $1,150,212, or 115.8%, to $2,143,237 for
the six months ended June 30, 2009, from $993,025 for the six months ended June
30, 2008, primarily due to the recognition of $1,115,783 non-operating expense
related to change in fair value of the Company’s outstanding
warrants.





Provision
for Income Tax





Income
tax was $2,183,939 for the six months ended June 30, 2009, as compared to
$1,550,138 for the six months ended June 30, 2008 which is in line with the
sales growth.





Net
Income





Based on
the foregoing, net income increased to $8,064,379 for the six months ended June
30, 2009, an increase of $1,742,916, or 27.6%, from $6,321,463 for the six
months ended June 30, 2008. Net margin stabilized at 20.5% in the six months
ended June 30, 2009 as compared to 20.5% in the six months ended June 30, 2008.
Increase in net income attributed to our increased revenues, supported by lower
natural gas procurement prices. The stable net margin reflects the increase of
net income, offset by the effect of non-operating expenses related to fair value
change of the Company’s outstanding warrants.





LIQUIDITY
AND CAPITAL RESOURCES





Historically,
our primary sources of liquidity have consisted of cash generated from our
operations and debt financing. In 2008, we sold senior notes with a face value
of $40 million to Abax Lotus Ltd. Our principal uses of cash have been, and are
expected to continue to be, for operational purposes as well as for constructing
and acquiring natural gas fueling stations and constructing our LNG
plant.





As of
June 30, 2009, the Company had $9,701,176 of cash and cash equivalents on hand
compared to $29,180,315 of cash and cash equivalents as of June 30, 2008. The
decrease was primarily attributable to the sale of senior notes to Abax Lotus
Ltd. in the amount of $40,000,000 during the six months ended March 31,
2008.





Net cash
provided by operating activities was $14,396,765 for the six months ended June
30, 2009 compared to net cash provided by operations of $8,126,132 for the six
months ended June 30, 2008. The primary reason for the change was due to the
increase in net income, adjusted for non-cash expenses items of $4,289,751 and
change in working capital of $2,042,635.





Net cash
used investing activities decreased from $30,394,475 during the six months ended
June 30, 2008 to $10,544,353 for the same period in 2009 primarily because
of our addition of fueling stations, prepayment to equipment suppliers
of the LNG plant and additions to our construction in progress during the six
months ended June 30, 2008. For the six months ended June 30, 2009, major cash
outflow were primarily to our construction in progress.


33





We had no
net cash provided by financing activities for the six months ended June 30,
2009, compared to net cash provided by financing activities of $37,877,491
during the six months ended June 30, 2008, due to the sale of senior notes to
Abax Lotus Ltd.





The
Company paid $10,372,858 to the LNG processing plant as a prepayment on
equipment as well as addition to construction in progress during the six months
ended June 30, 2009.





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 for
at least the next 12 months.





The
majority of our revenues and expenses were denominated primarily in RMB, the
currency of the People's Republic of China. 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





None.





CAPITAL
EXPENDITURES





Our
planned capital expenditures as of June 30, 2009 were $35 million, which we
expect to be incurred in connection with the construction of our LNG facility,
joint-venture cooperation with CNPC Kunlun and the acquisition of additional CNG
fueling stations. To the extent we engage in additional projects in the near
future and to the extent we do not have sufficient internal financial resources
to fund capital expenditures associated with such projects, we will need to
obtain additional financing to fund such capital expenditures from third party
sources, including from the capital markets.





CONTRACTUAL
OBLIGATIONS





Our
contractual obligations are as follows:




Payments due by periodContractual obligations
                          
                          Total
                          
                          
                          Less than
                            1 year
                          
                          
                          1-3
                            years
                          
                          
                          3-5
                            years
                          
                          
                          More than
                            5
      years(in thousands)Long-Term
      Debt Obligations
                          
                          
                          40,000
                          
                          
                          
                          -
                          
                          
                          
                          6,667
                          
                          
                          
                          33,333
                          
                          
                          $
                          -Other
      Long-Term Liabilities Reflected on Company's Balance
      Sheet
                          
                          
                          17,500
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          17,500
                          (1)Total
                          
                          
                          57,500
                          
                          
                          
                          -
                          
                          
                          
                          6,667
                          
                          
                          
                          33,333
                          
                          
                          $
                          17,500




Note:




(1)
              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. If
      Abax does not exercise the warrants by January 29, 2015, Abax will be
      entitled to require that we purchase the warrants for $17,500,000 at that
      time.




COMMITMENTS
AND CONTINGENCIES





Lease
Commitments





We
recognize lease expense on a straight-line basis over the term of the lease in
accordance to FAS 13, “Accounting for leases.” We entered into series of
long-term lease agreements with outside parties to lease land use right to the
self-built natural gas fueling stations located in the PRC. The agreements have
terms ranging from 10 to 30 years. We make annual prepayment for most lease
agreements.  We also entered into two office leases in Xian, PRC and
New York, NY.  The minimum future payment for leasing land use rights
and offices is as follows:


34





Year
      ending December 31, 2009
                  
                  $
                  430,734Year
      ending December 31, 2010
                  
                  
                  1,458,518Year
      ending December 31, 2011
                  
                  
                  1,577,171Year
      ending December 31, 2012
                  
                  
                  1,339,207Year
      ending December 31, 2013
                  
                  
                  1,280,490Thereafter
                  
                  
                  21,923,925Total
                  
                  $
                  28,010,045





For the
three months ended June 30, 2009 and 2008, the land use right and office lease
expenses were $406,016 and $ 310,698, respectively. For the six months ended
June 30, 2009 and 2008, the land use right and office lease expenses were
$798,097 and $373,945 respectively.




Property
and Equipment





On
January 25, 2008, we entered into a contract with Chemtex International Inc.
("Chemtex") to acquire certain exclusive rights relating to the technical
know-how and designing of our LNG plant and LNG storage tank in Jingbian county,
Shaanxi province, China, in the total amount of $9,500,000.  On April
13, 2008, our subsidiary, XXNGC, entered into a contract with Chemtex to
purchase equipment supply for the LNG plant and LNG storage tank in the total
amount of $13,700,000 (the "Chemtex Purchase Agreement"). The $13,700,000
purchase price was reduced to $13,100,000 under an amendment to the Chemtex
Purchase Agreement with Chemtex in September 2008.  On May 16, 2008,
SJLNG entered into an agreement with Hebei Tongchan Import and Export Co. Ltd.
("Hebei") and agreed that Hebei will act as the trade agency for SJLNG. On June
18, 2008, XXNGC amended the April 13, 2008 with Chemtex and assigned Hebei to
purchase the LNG equipment for the LNG plant and LNG storage tank and Hebei
succeeded the rights and obligations of XXNGC under Chemtex Purchase
Agreement.





As of
June 30, 2009, we advanced $6,299,500 to Hebei and the future commitment for
equipment is $7,400,500.





Natural
Gas Purchase Commitments





We have
certain effective natural gas purchase agreements with our major suppliers. The
natural gas purchase agreement with Shaanxi Provincial Natural Gas Co., Ltd. has
been renewed annually to date and specifies a maximum amount that can be
purchased but does not specify a minimum amount that must be purchased. Our
natural gas purchase agreements with certain suppliers of coal-bed methane are
of indefinite terms and do not contain either maximum or minimum amounts of
purchase. Without minimum purchase requirements under any of our natural gas
purchase agreements, we have the flexibility to constantly look for lower-cost
sources of supply.





Legal
Proceedings





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.
Regardless of the outcome of the appeal, we believe that any liability we would
incur will not have a materially adverse effect on our financial condition or
our results of operations.


35


FOREIGN
CURRENCY TRANSLATIONS





As of
June 30, 2009 and December 31, 2008, our accounts were maintained, and our
consolidated financial statements were expressed in RMB.  Such
consolidated financial statements were translated into USD in accordance with
Statement of Financial Accounts Standards ("SFAS") 52, "Foreign Currency
Translation," with the RMB as the functional currency. According to SFAS 52, all
assets and liabilities were translated at the exchange rate as of the balance
sheet date, stockholders’ equity were translated at the historical rates and
statement of income and cash flow items were translated at the weighted average
exchange rate for the year. The resulting translation adjustments are reported
under other comprehensive income in accordance with SFAS 130, "Reporting
Comprehensive Income."  In accordance with SFAS 95, "Statement of Cash
Flows," cash flows from the Company's operations is calculated based upon the
local currencies and translated to USD at average translation rates for the
period. As a result, translation adjustments amounts related to assets and
liabilities reported on the consolidated statement of cash flows will not
necessarily agree with changes in the corresponding consolidated balances on the
balance sheet.





The
balance sheet amounts with the exception of equity at June 30, 2009 were
translated RMB6.83 to $1.00 as compared to RMB6.82 at December 31, 2008. The
equity accounts were stated at their historical rate. The average translation
rates applied to income and cash flow statement amounts for the six months ended
June 30, 2009 and 2008, were 6.82 RMB and 7.05 RMB to $1.00,
respectively.





CRITICAL
ACCOUNTING POLICIES





Revenue
Recognition





Our
revenue recognition policies are in accordance with Staff Accounting Bulletin
(SAB) 104. Revenue is recognized when services are rendered to customers 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. The construction contracts are usually completed within one to two
months. Revenue from repairing and modifying vehicles is recorded when service
are rendered to and accepted by the customers.





Accounts
Receivables





Accounts
and other receivables are recorded at net realizable value consisting of the
carrying amount less an allowance for uncollectible accounts, as needed. The
Company allowance for uncollectible accounts is not significant.





We
maintain reserves for potential credit losses on accounts receivable. Management
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
these reserves. Reserves are recorded primarily on a specific identification
basis. Our management determined that all receivables are good and there is no
need for a bad debt reserve as of June 30, 2009.




Other
Receivable – Employee Advances





From time
to time, we advance predetermined amounts based upon internal Company policy to
certain employees and internal units to ensure certain transactions to be
performed in a timely manner. We have full oversight and control over the
advanced accounts. Therefore, no allowance for the uncollectible accounts is
needed.





Inventory





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


36





Fair
Value of Financial Instruments





FAS 107,
“Disclosure About Fair Value of Financial Instruments” defines financial
instruments and requires fair value disclosure of applicable financial
instruments. FAS 157, “Fair Value Measurements,” adopted January 1, 2008,
defines fair value, establishes a three-level valuation hierarchy for
disclosures of fair value measurement and enhances 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:





·
            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.





We
analyze all financial instruments with features of both liabilities and equity
under SFAS 150, “Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity,” SFAS 133, “Accounting for
Derivative Instruments and Hedging Activities” and EITF 00-19, “Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock.”





As
required by SFAS 157, 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.





Effective
January 1, 2009, we adopted the provisions of EITF 07-5, "Determining Whether an
Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock”, which is
effective for financial statements for fiscal years beginning after December 15,
2008 and which replaced the previous guidance on this topic in EITF 01-6.
Paragraph 11(a) of FAS 133 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 in stockholders’ equity in the statement of financial
position would not be considered a derivative financial instrument. EITF 07-5
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 FAS 133 paragraph 11(a) scope exception.





Unearned
Revenue





Unearned
revenue represents prepayments by customers for gas purchases and advance
payments on installation of pipeline contracts. We record such prepayment as
unearned revenue when the payments are received.


37


RECENT
ACCOUNTING PRONOUNCEMENTS





In
January 2009, the FASB issued FSP EITF 99-20-1, “Amendments to the Impairment
Guidance of EITF Issue No. 99-20, “Recognition of Interest Income and Impairment
on Purchased and Retained Beneficial Interests in Securitized Financial Assets”.
FSP EITF 99-20-1 changes the impairment model included within EITF 99-20 to be
more consistent with the impairment model of SFAS 115. FSP EITF 99-20-1 achieves
this by amending the impairment model in EITF 99-20 to remove its exclusive
reliance on “market participant” estimates of future cash flows used in
determining fair value. Changing the cash flows used to analyze
other-than-temporary impairment from the “market participant” view to a holder’s
estimate of whether there has been a “probable” adverse change in estimated cash
flows allows companies to apply reasonable judgment in assessing whether an
other-than-temporary impairment has occurred. The adoption of FSP EITF 99-20-1
did not have a material impact on our consolidated financial statements because
all of our investments in debt securities are classified as trading
securities.





In April
2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and
Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly” (FSP FAS 157-4). FSP FAS 157-4
amends SFAS 157 and provides additional guidance for estimating fair value in
accordance with SFAS 157 when the volume and level of activity for the asset or
liability have significantly decreased and also includes guidance on identifying
circumstances that indicate a transaction is not orderly for fair value
measurements. This FSP shall be applied prospectively with retrospective
application not permitted. The adoption of FSP FAS 157-4 did not have a material
impact on our consolidated financial statements.





In April
2009, the FASB issued FSP FAS 115-2 and FAS 124-2. This FSP amends SFAS 115,
“Accounting for Certain Investments in Debt and Equity Securities,” SFAS 124,
“Accounting for Certain Investments Held by Not-for-Profit Organizations,” and
EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on
Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held
by a Transferor in Securitized Financial Assets,” to make the
other-than-temporary impairments guidance more operational and to improve the
presentation of other-than-temporary impairments in the financial statements.
This FSP will replace the existing requirement that the entity’s management
assert it has both the intent and ability to hold an impaired debt security
until recovery with a requirement that management assert it does not have the
intent to sell the security, and it is more likely than not it will not have to
sell the security before recovery of its cost basis. This FSP provides increased
disclosure about the credit and noncredit components of impaired debt securities
that are not expected to be sold and also requires increased and more frequent
disclosures regarding expected cash flows, credit losses, and an aging of
securities with unrealized losses. Although this FSP does not result in a change
in the carrying amount of debt securities, it does require that the portion of
an other-than-temporary impairment not related to a credit loss for a
held-to-maturity security be recognized in a new category of other comprehensive
income and be amortized over the remaining life of the debt security as an
increase in the carrying value of the security. The adoption of FSP FAS 115-2
and FAS 124-2 did not have a material impact on our consolidated financial
statements.





In April
2009, the FASB issued FSP FAS 107-1 and APB 28-1. This FSP amends SFAS
No. 107, “Disclosures about Fair Value of Financial Instruments,” to
require disclosures about fair value of financial instruments not measured on
the balance sheet at fair value in interim financial statements as well as in
annual financial statements. Prior to this FSP, fair values for these assets and
liabilities were only disclosed annually. This FSP applies to all financial
instruments within the scope of SFAS 107 and requires all entities to disclose
the method(s) and significant assumptions used to estimate the fair value of
financial instruments. The adoption of FSP FAS 107-1 and APB 28-1 did not have a
material impact on our consolidated financial statements.





In May
2009, the FASB issued Statement of Financial Accounting Standards No. 165,
“Subsequent Events,” (FAS 165, Subsequent Events [ASC 855-10-05], which provides
guidance to establish general standards of accounting for and disclosures of
events that occur after the balance sheet date but before financial statements
are issued or are available to be issued. FAS 165 also requires entities to
disclose the date through which subsequent events were evaluated as well as the
rationale for why that date was selected. FAS 165 is effective for interim and
annual periods ending after June 15, 2009, and accordingly, we adopted this
Standard during the second quarter of 2009. FAS 165 requires that public
entities evaluate subsequent events through the date that the financial
statements are issued. We have evaluated subsequent events through the time of
filing these consolidated financial statements with the SEC on August 10,
2009.





In June
2009, the FASB issued Statement No. 166, Accounting for Transfers of Financial
Assets – an amendment of FASB No. 140 (“FAS 140”), Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities (“FAS 166”)
[ASC 860]. FAS 166 amends the criteria for a transfer of a financial asset to be
accounted for as a sale, redefines a participating interest for transfers of
portions of financial assets, eliminates the qualifying special-purpose entity
concept and provides for new disclosures. FAS 166 is effective for the Company
beginning in 2010. Should the Company’s accounts receivable securitization
programs not qualify for sale treatment under the revised rules, future
securitization transactions entered into on or after January 1, 2010 would be
classified as debt and the related cash flows would be reflected as a financing
activity. We are currently assessing the impact of the standard on its
securitization programs.


38





In June
2009, the FASB issued Statement of Financial Accounting Standards No. 167,
Amendments to FASB Interpretation No. 46(R) (“FAS 167”) [ASC 810-10], which
modifies how a company determines when an entity that is insufficiently
capitalized or is not controlled through voting (or similar rights) should be
consolidated. FAS 167 clarifies that the determination of whether a company is
required to consolidate an entity is based on, among other things, an entity’s
purpose and design and a company’s ability to direct the activities of the
entity that most significantly impact the entity’s economic performance. FAS 167
requires an ongoing reassessment of whether a company is the primary beneficiary
of a variable interest entity. FAS 167 also requires additional disclosures
about a company’s involvement in variable interest entities and any significant
changes in risk exposure due to that involvement. FAS 167 is effective for
fiscal years beginning after November 15, 2009. We are currently assessing the
impact of the standard on its securitization programs.





In June
2009, the FASB issued Statement of Financial Accounting Standards No. 168, The
FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted
Accounting Principles a Replacement of FASB Statement No. 162 (“FAS 168”). This
Standard establishes the FASB Accounting Standards CodificationTM (the
“Codification”) as the source of authoritative accounting principles recognized
by the FASB to be applied by nongovernmental entities in the preparation of
financial statements in conformity with U.S. GAAP. The Codification does not
change current U.S. GAAP, but is intended to simplify user access to all
authoritative U.S. GAAP by providing all the authoritative literature related to
a particular topic in one place. The Codification is effective for interim and
annual periods ending after September 15, 2009, and as of the effective date,
all existing accounting standard documents will be superseded. The Codification
is effective for us in the third quarter of 2009, and accordingly, our Quarterly
Report on Form 10-Q for the quarter ending September 30, 2009 and all subsequent
public filings will reference the Codification as the sole source of
authoritative literature.





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 central and local governments and doesn’t fluctuate much
at all. Such a price involatility situation is expected to continue for
operations in China. We currently don’t have any hedge positions in place to
reduce our exposure to changes in natural gas whole sale 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 $40 million at June 30, 2009, all of which bears interest at
fixed rates. The $40 million of fixed-rate debt is due on 2014. We currently
have no interest rate hedge positions in place to reduce our exposure to changes
in interest rates.





Foreign Currency Exchange
Rates Risk





We
operate in China 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 China local
currency are translated into U.S. dollars using the exchange rates in effect at
the balance sheet date, resulting in translation adjustments that are reflected
as Cumulative Translation Adjustment in the shareholders’ equity section on our
Consolidated Balance Sheets. A portion of our net assets are impacted by changes
in foreign currencies in relation to the U.S. dollar. We recorded a $2,997
adjustment to decrease our equity account for the quarter ended June 30, 2009 to
reflect the net impact of the fluctuating of Chinese currency against the U.S.
dollar.


39





Item 4. Controls and
Procedures





Evaluation
of Disclosure Controls and Procedures




The
Company's management has evaluated, under the supervision and with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, the effectiveness of the design and operations of the Company's
disclosure controls and procedures (as defined in Securities Exchange Act Rule
13a-15(e)), as of the end of the period covered by this quarterly report. Based
on that evaluation, the Company's Chief Executive Officer and Chief Financial
Officer have concluded that the evaluation of the effectiveness of our
disclosure controls and procedures was completed; our disclosure controls and
procedures were not effective.





Changes
in internal control over financial reporting





We are
devoting significant resources to remediating and improving our internal
controls. From the second quarter of 2009, the Company has started to
independently completing the consolidation of its financial statements in
accordance with U.S. GAAP through recruiting of U.S. GAAP proficient accounting
personnel. We are also allocating additional resources to train our existing
accounting staff and will continue this effort in the future. Most of the
policies, procedures and practices are already in place and being implemented.
These initiatives include the following:





·
            Identifying
      and hiring additional personnel with U.S. GAAP and SEC reporting
      experience, including our new CFO Veronica Jing Chen and one ACCA (Association of Chartered
      Certified Accountants) affiliate, and starting to independently
      completing the U.S. GAAP based reporting in the second quarter of
      2009;·
            Recruiting
      of additional qualified accounting personnel to form a competent SEC
      reporting team;·
            Hiring
      outside consultant to provide training to our finance
      personnel;·
            Based
      on COSO framework, developing the scope of the Company’s internal control
      system and enhancing the internal control function by establishing the
      Company’s internal audit team containing one corporate control director
      and two full time employees;


·
            Introducing
      and implementing policies and procedures to effectively control daily cash
      transactions and recording;




Except as
described above, there were no
changes in our internal control over financial reporting during the quarter
ended June 30, 2009 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial
reporting.




Part II. OTHER INFORMATION





Item 1. Legal Proceedings





A former
member of the board of directors filed a lawsuit 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 options 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. Regardless of the
outcome of the appeal, the Company believes that any liability it would incur
will not have a materially adverse effect on its financial condition or its
results of operations.


40





Item
1A. Risk Factors




As of the
date of this filing, there have been no material changes from the risk factors
disclosed in the Company’s Annual Report on Form 10-K/A filed on July 20, 2009.
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/A 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 occur, our business, financial
condition or results of operations may be adversely affected.





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





None.





Item 3.   Defaults Upon Senior
Securities





None.





Item 4.   Submission of Matters to a Vote of
Security Holders





None.





Item 5.   Other Information





None





Item 6.   Exhibits





(a)
Exhibits




Exhibit Number
                
                Description
      of Exhibit31.1*
                
                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
      amended31.2*
                
                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
      amended32.1*
                
                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)


*Filed
herewith


41


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.August
      10, 2009
                  By:
                  /s/ Qinan
      JiQinan
      Ji
                    Chief
      Executive Officer
                    (Principal
      Executive
Officer)





August
      10, 2009
                  By:
                  /s/ Veronica
      ChenVeronica
      ChenChief
      Financial Officer(Principal
      Financial and Accounting
Officer)


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