Green Dragon rides China CBM wave
Independent cracks Chinese coal-bed methane challenge
Damon Evans, SINGAPORE: Green Dragon Gas is positioning itself to ride China’s unconventional wave after unlocking what it
claims are the secrets to success in the country’s fledgling coal-bed methane (CBM) sector.
Following several years developing techniques to overcome the challenges posed by Chinese CBM, the London-listed outfit is on
the cusp of being a leap forward in production. The Chinese-based independent expects to hit a production rate of 18 billion cubic feet per year (cf/y) by the end of 2013, up from 1.3 billion cff/y in 2011, as it ramps up its drilling campaign.
For the outfit, which has been operating in China since the 1990s and is the only company still active from the original wave of pioneers, time is a crucial function of its success.
The firm is no longer spending years developing technology, but is now deploying that technology more effectively. Gas production will improve as a results, Green Dragon chief executive Randeep S Grewal, told PEU.
And while the recent influx of new entrants has perked interest in China’s emerging CBM scene, Grewal offers would be explorers a word of caution. Geologically speaking, new explorers will have to go though several cycles of technical development, just like Green Dragon, before they can start significant gas production. Generic off the shelf approaches will not work in China as extraction techniques have to be tailored specifically to local conditions, Grewal reckons.
It’s the third time exploration companies have rushed into China’s CBM sector. This latest round has been spurred similarly by comparatively high gas prices, rising consumption and increasing transparency, all of which make for a unique environment that benefits the producer.
Cracking the code
Green Dragon bagged its first CBM contract in China in 1999 and snapped up average in the Qinshui basin in 2003. Whilst
hightly prospective with high gas content, the geology of the Qinshui basin initially posed challenges with its brittle, heavily faulted coal seams and low permeability coals. Faulted seams make it more difficult to drill horizontal sections that stay in-seam, low permeability implies lower gas productive capacity, while brittle coals tend to collapse and plug the well bore.
But, over the past eight years, Green Dragon has adapted its drilling ways to maximise production.
After attempting vertical drilling, short radius and multi-lateral horizontal drilling, the company achieved higher and more consistent recovery rates from surface to in-sean(SIS) wells. Green Dragon now uses this method. And, it has developed its own advanced proprietary drilling technology manufactured in Italy, coined LiFaBric (Lines, Faulted, Brittle coal wells)
Unlike other fuels in China which have state-set prices, CBM can be sold at market prices without a regulatory regime. But, with no open access pipeline mechanism, multiple exit pathways for upstream producers are vital in China.
Credit Suisse says multiple sales channels will unlock added value for Green Dragon. Positively, the independent continues to build out an integrated gas value and is the only CBM operator that has a downstream sales license in China.
Green Dragon is bust developing 31 compressed natural gas (CNG) retail stations – which will have 4 billion cf of compression capacity by the end of-2012- to take its gas directly to the consumer for the highest netback possible. CNG is used primarily by taxi and trucking fleets, offering a 25% discount to gasoline.
The company sells CNG at its Henan stations for more than $15,;000 cf. Based on production costs of $2/’000 cf and with well-held prices in Shanxi at $8/’000 cf Credit Suisse estimates the firm can net a healthy profit of $6/’000 cf. Adding $1.25/’000 cf for compression and a further $2.5/’000 cf for shipping leaves a further $3.2/’000 cf profit at the retail level.
Elsewhere, Green Dragon is posed to seal a deal with PetroChina to supply initial volumes ranging from 2.58-6.45 billion cf/y into the state-run firm’s WestEast1 pipeline. Macquarie expects the firm to bag a wellhead price of some $5-6/’000 cf for these flows, plus the $0.9/’000 cf state CBM subsidy.
All bets are on
Analysts are betting that Green Dragon will outperform its current share price trading around $9.50 by more than 60% by the end of this year as production looks set to take off, while anticipated reserve upgrades offer substantial upside. The company has an audited 25.5 trillion cf of original gas-in-place, 273 billion cf of which is classifies as proved plus probable (2P) reserves.
Macquarie says the investment case is a play on the firm’s ability to develop core reserves and thereby unlock significant value that is as yet barely recognised by the market.
Unconventional gas matters in China. Beijing wants to significantly boost its use of gas, specifically domestically sourced gas rather than high-cost gas imports. Effectively, Green Dragon’s strategy is perfectly aligned with the Chinese authority’s desire to increase
natural gas in the energy mix and substitute diesel and gasoline with CNG in large urban transport fleets.
Energy consultancy Wood Mackenzie predicts Chinese natural gas demand will hit 18 trillion cf/y by 2030, up from the estimated 4.6 trillion cf in 2011.
Green Dragon is no exception to the usual exploration, development, cost and contractual risks, but if anything the perception is that its risks are higher than most, mainly because it’s a small foreign owned company operating in China and it has as yet unresolved
difference, with its local partner CUCBM in some of its blocks. But, the risks are lower than you might think argues Macquarie.
In 2011, the previous management of CUCBM, Green Dragon’s local partner for five of its six production sharing contracts (PSC) announced it would no longer work with them on four of the five permits. This was widely assumed to mean that Green Dragon had lost its right on those blocks. But the reality is quite different.
As Green Dragon was an early mover into CBM in China its licences can only be changed with the approval of the State Council and not CUCBM. Macquarie have suggested the move was an attempt by CUCBM to put pressure on Green Dragon to get preferential rights over gas sales. But due to the way the permits were put in place, they have no real leverage to be able to do that.
Chinese national oil company CNOOC now holds a 50% stake in CUCBM, reflecting Beijing’s desire to focus on ramping up CBM production. CNOOC’s farm-in should bring both management focus to gas production and funding to facilitate its participation in blocks such as Shizhuang South, which will be positive for Green Dragon, says Credit Suisse.
Green Dragon, despite being listed in the UK, is for all intents and purposes a Chinese company, and it has been part of the local economy since the 1990s. And, notably, Grewal, having spent 19 years in China, is possibly the only Westerner to be accepted onto a local authority board.
And with the government seeking to encourage foreign expertise in the unconventional gas sector and CBM standing to ramp up production in a number of the 38 PSCs held by foreign independents, it seems unlikely that the authorities will allow CUCBM to jeopardise future foreign cooperation.Read more