Part Two: Will China’s Coalbed Methane Projects Make a New Energy Billionaire?
Green Dragon CBM Concessions
While Green Dragon Gas has been blessed with the first production sharing contracts it negotiated through Greka Energy, which offer the hope of several trillion cubic feet of coal bed methane gas, there could be serious obstacles to extracting the gas. methane. In a May 2006 research report, the underwriters warned that GDG “faces a combination of undersaturation, low permeability, and low coal seam thickness that makes much of this resource difficult to market.” Any CBM-versed investor would look the other way after reading this series of hurdles GDG must overcome to commercially produce methane gas.
Despite this bleak assessment, Smith & Williamson stood by and backed Green Dragon Gas. Research analyst James Elston wrote: “However, innovation by Green Dragon and its world-class Chinese contractors should enable significant improvements in recoverable reserves over time, especially with rising gas prices.” That’s the blue sky aspect of Green Dragon: making a wasteful, but very large, project come to fruition. Because the coals are undersaturated and because there is low permeability, conventional wells would bring low methane gas productivity.
A big vote of confidence, and one that resulted in our writing on this company, came after noticing two big names appearing on the company’s board of directors: John Turnbull and John Stewart. Formerly chairman of Swire Group and Cathay Pacific airlines, Turnbull was once a Hong Kong “Taipan”. Stewart John was awarded the Order of the British Empire (OBE) and was part of Turnbull’s executive team at Hong Aircraft Engineering Company and Cathay Pacific. Mr. John has also been a non-executive director of British Aerospace and Rolls Royce.
A look at GDG’s technical team shows strength. Not only are they all senior Chinese technicians, but they are also proven engineers, drillers or geologists with ties to the oil, gas and/or coal sectors. The chief engineer, Zuo Kefeng, has 23 years of experience in vertical, horizontal and multi-well drilling. The chief geologist has 20 years of CBM experience at the coal office level. COO Mel Lone has been Greka Energy’s chief representative and general manager in China since 2001. On the surface, Grewal recruited the crème de la crème.
Of the five production sharing contracts, covering more than 1.6 million acres, parts of their concessions may be sub-economic. Smith & Williamson created a base case between 592 and 1,000 bcf net, which would support its valuation of the company of just under $1 billion. The research analyst said: “Further successful evaluation and testing coupled with further optimization of development techniques could make increasing amounts of this vast in situ reserve economically developable.” That is what we expect.
The brokerage firm’s valuation was reached on the basis of between three and six percent of the gas at the site touted by GDG. Why is that? Of the five concessions, the most advanced block is Shizhuang South. The research analyst reported that “evaluation of the other licenses (are) still relatively immature.” Shizhuang South currently produces about 265 mcf per day from pilot wells that feed a gas-fired electricity generator. The current estimated recoverable reserves for this block are 417 bcf (gross), comprising the majority of Green Dragon’s valuation of the brokerage firm.
It is anticipated that by the end of 2006 or early 2007, Green Dragon will have obtained approval of an overall development plan to begin full-scale development. Additional exploration and development can potentially show increased spud counts in ceremonies for individual wells on the Quinyan and Fengcheng blocks during July, so additional exploration and development activity can help increase the number of recoverable reserves and eventually in turn, the valuation of the company.
Two key CBM competitors in China
Surrounding one of GDG’s Shizhuang properties is a much larger block held by Far East Energy. In association with ConocoPhillips, Far East Energy’s share could reach up to 6.9 tcf. Exploration drilling at the company’s Shanxi project is reportedly advanced but requires production testing. As with GDG, Far East Energy has a massive block of over a million. According to the Yunnan Provincial Coal Bureau, there are four coal seams with an average thickness of nine feet. The total thickness of the coal seam is 60 feet. While GDG’s recoverable reserves range from 16 to 28 percent, according to the research analyst reporting on Green Dragon, Far East Energy notes on its website that a 50 to 65 percent recovery is possible. Previous tests have shown economic gas content of 200 to 500 cubic feet of gas per ton of coal.
Far East also boasts that the company could have one of the largest CBM projects in the world during its full development. The company believes the Shanxi project could support some 3,000 horizontal gas wells. Investors should note that unlike conventional “drill and forget” natural gas reserve development, where one or two wells can recover 30 bcf of gas, CBM is different. Hundreds of wells may be required to extract methane gas from coal seams horizontally. While well drilling and casing cost less, maintenance and operations cost more. CBM production can be spread over a longer period, sometimes for several decades, to deplete the reservoir.
Another key competitor, and potentially a partner to other CBM companies in China, including coal companies that also produce methane gas, is Pacific Asia China Energy (PACE). As with Green Dragon and Far East Energy, PACE has a very large ownership position with estimated gas in place of up to 11.2 trillion cubic feet. PACE holds two licences, the same number as Far East Energy. Exploration drilling to confirm the China Coal Bureau data is ongoing.
PACE expects to start a pilot production project in late 2006 if current drilling confirms an independent technical report, which was prepared by Sproule International. Press releases updating the company’s progress indicate good permeability and thickness in the coal seams. More than a month ago, news reported that the company’s drilling confirmed the “most likely case scenario” for the 5.2tcf Guizhou project.
What is likely to create strong momentum for PACE, however, is its joint venture with Australia’s Mitchell Drilling Services. Both Green Dragon Gas and Far East Energy will likely require something on the order of this joint venture’s proprietary Dymaxion® drilling technology to increase recovery capacity. While PACE has the smallest footprint and least amount of gas on site of this trio of CBM companies, the company has one solid advantage: PACE may be able to extract more gas more cheaply. In an earlier interview with Nathan Mitchell, head of the drilling company, he was confident of being able to extract CBM gas at a cost that could transform even the least economical projects into commercially viable ones. According to previous interviews with Mitchell and Steve Khan, executive vice president of PACE, the first Dymaxion® drill rig should arrive in China later this year.
conclusion
By 2020, China expects CBM to be able to provide up to 10 percent of the country’s gas production. CUCBM will continue to lead China’s coalbed methane development. But, others that are currently developing their production sharing contracts could also become strong suppliers of methane gas in China.
Europeans seem to appreciate CBM in China more than US funds. A large portion of Western Hemisphere funding is earmarked for CBM exploration and development in Western Canada. Inflated gas storage figures hit CBM shares very hard last June and caused the sector to disappoint investors.
While CBM companies developing their projects in Alberta or elsewhere in Canada may have to wait until natural gas prices recover or become part of the consolidation process, CBM companies in China are in a completely different market. In addition to being the world’s largest coal producer, China has a huge amount of CBM gas in place. Unlike Canada, China is frantically negotiating to import more natural gas to keep its gas-fired plants running. The addition of coalbed methane gas would be welcome. According to industry experts we have talked to, China’s state-owned CUCBM has been doing its best to make CBM projects in China come to fruition. Investors need to realize that CBM in China is a completely different world than CBM in Canada.
An industry insider explained to us: “Green Dragon Gas will probably boost the entire CBM sector in China.” With these three CBM companies already in the game, two to three other Canadian CBM development companies may soon begin exploration of their projects. And sooner rather than later, more will join. And who knows? Randeep Grewal could join the billionaires club next year. Of one thing we are sure, if he achieves that premiership status, CUCBM will have more foreign investment rushing to capitalize on China’s CBM production sharing contracts.
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