Sam Kiri CFA
Proactive Investors
As China continues its development exploits, the need to develop energy sources has gained more eloquence. Environmental concerns have prompted China to look for other avenues to replace coal based energy in the energy equation. Coal Bed Methane (CBM) is fast emerging as an attractive alternative, thus strengthening the investment case of China based CBM companies.
Economic development is never without victims. In the case of China the victim is the environment. Along with its impressive 10% GDP growth the Chinese energy consumption has been rising at 11% per annum over the last five years. China's insatiable demand for energy is indicated by its fuel consumption. During the last five years, the Chinese annual oil consumption has increased by 8% to reach 7.2 mmbbl per day. More imposing is the staggering 15% annual growth in gas consumption. Natural gas continues to assume a greater role in the Chinese energy equation and in 2006 China consumed 2 billion cubic feet of natural gas.
By the end of 2005, China had an installed generation capacity of 500 million kW with an annual electricity generation of 2.4 trillion kWh, making China the world's second largest power generator. A further 100 million kW were added to its power generating capacity in 2006. Despite new additions, China's projected long run electricity demand growth of 9-10% falls short of the projected generation capacity growth of 4-5% per annum. China certainly is keen to develop its energy sources to meet the rising demand.
Much of China's energy comes from coal power plants. China currently produces 1 billion tonnes of coal per annum to generate 75% of its energy needs. In view of high emissions and environmental pollution, China plans to reduce the proportion of coal based energy to 63% by 2010. Against this backdrop, the increased use of other sources in the energy equation has now become a priority. This includes power generation through unconventional sources such as Coal Ben Methane (CBM).
CBM is methane found in coal seams produced either by biogenic (by microbes) or thermogenic (by heat) routes. It is a more environmentally friendly power generation alternative as it does not produce sulfur dioxide (SO2) and produces only 50% of the carbon dioxide (CO2) emitted through coal combustion. The US has the most developed CBM industry due to the presence of large coal basins. CBM now accounts for 8% of the US natural gas production.
According to China United Coal Bed Methane (CUCBM) China has CBM resources of 36.8 trillion cubic metres (Tcm) within its extensive coal deposits spanning across the country. China has the third largest CBM resources after Russia and Canada and twice as much as the US resources, the CBM industry leader. CUCBM expects CBM production to reach 10 billion cubic feet (Bcf) and account for 20-25% of China's gas energy by 2010. CUCBM is a state agency with exclusive right to explore and develop CBM resources in joint venture with foreign companies.
Attempts are currently underway to realize such lofty targets. Since 1998, CUCBM has signed over thirty production-sharing contracts (PSCs) with several renowned energy companies to develop its CBM riches. CBM PSCs started with energy majors such as Texaco, Arco, ConocoPhillips, Greka and Australia's Lowell oil. Having realized the role more focused companies can play in the CBM space, CUCBM subsequently invited several smaller but specialized firms such as Pacific Asia China Energy (TSX: PCE.V), Far Eastern Energy (FEEC.OB), Verona Development Corp. (VDC.V), Green Dragon Gas (London AIM: DI), etc to participate in the development of Chinese CBM resources. These firms have made considerable progress in their respective projects.
The development of CBM industry is also expected to reduce China's notorious coal mining accidents. China has the dubious honour of recording the highest number of coal mine accidents in the world with most of them caused by methane explosions. CBM drainage is expected to reduce the risk of methane explosions and sudden outbursts of coal and gas, leading to considerably improved safety conditions. Reduced down time due to accidents and improved reputation provide additional incentives for China to develop its CBM industry.
However it is the quest to establish secure energy sources locally, preferably the cleaner variety, is what is driving the Chinese CBM market. China is a signatory to the UN Framework Convention on Climate Change (FCCC) and the Kyoto Protocol, both of which seek the reduction of greenhouse gas emissions. China is also aware of pollution related environmental damage and health costs which the World Bank estimates to be as high as US$54bn/year. CBM clearly is high on China's energy agenda.
The success of CBM projects heavily depends on the availability of coal resources and China has them in abundance. China is currently the largest coal producer and has the third largest coal resources in the world after Russia and the UK. China's vast coal resources virtually guarantee CBM resources and augur well for China's CBM aspirations.
Offering further comfort is the role played by the Chinese government in the development of CBM resources. In May 1996, the State Council established CUCBM as a state agency to oversee the CBM sector with the mandate to commercialise the exploration, development, marketing, transportation and utilization of CBM. CUCBM is jointly owned by PetroChina Company Ltd and China National Coal Group and enters into PSCs with foreign companies. CBM companies also benefit from generous government incentives such as a two-year income tax holiday and reduced value-added tax and royalty. CUCBM has not been a greedy government authority keen on milking CBM ventures. Country risk it appears is minimal for CBM companies in China.
This makes companies that provide exposure to the Chinese CBM industry distinctly attractive investments. The industry however requires focused, technologically savvy operators thus making pure CBM players equally appealing due to their focused approach and greater commitment. Thus companies such as Pacific Asia China Energy, Far Eastern Energy, Verona Development Corp., Green Dragon Gas and Ivana Ventures (ANA.V) warrant a closer look.
The greatest positive about pure CBM players is the direct exposure it provides to the China CBM story. Most of them extensively use a local workforce which usually leads to strong relationships with authorities. More importantly, they are still not on the radar screen of larger institutional investors and appear to be relatively under valued. While they are yet to reach the production stage, they have made considerable progress in their respective projects and are well poised to benefit from the expected growth of the Chinese CBM sector.
For instance, London listed Green Dragon Gas is developing CBM resources in Shanxi, Jiangxi and Anhui provinces with a plan to drill 80 wells by February 2008. Cumulative production from pilot wells drilled on the Chengzhuang section has exceeded 5.5 mmcf so far. Pacific Asia China Energy has two projects in Guizhou and Hubei provinces. According to an independent technical report by Sproule International, the Guizhou project has an estimated potential gas resource of 11.2 Tcf. Ivana Ventures has two projects in Xinjiang and Anhui with several exploration wells. Verona Development Corp has two projects in Shanxi (Shanxi project) and Henan provinces (Zhenzhou project) at varying stages of exploration. Meanwhile, Far Eastern Energy has two PSCs with CUCBM and two farm-out agreements with a subsidiary of ConocoPhillips in China.
Despite their ongoing projects and the exposure they provide to the burgeoning Chinese CBM sector, they have attracted little investor interest. Strong fundamentals surrounding the Chinese natural gas sector underpin the fortunes of alternative gas sources such as CBM. With the regulatory environment providing an equally strong support for CBM players, the sector appears to be well set to take off.
Editor's Note: Sam Kiri is a Director of Proactive Investors North America Inc, a financial media forum focused on small to mid cap companies. He is also involved in listing North American companies on the London Alternative Investment Market (AIM). www.proactiveinvestors.co.uk
