It’s hardly surprising that the share price of Green Dragon Gas has soared recently. The plan to list on the Hong Kong board in addition to the existing AIM listing has stimulated many investors: this coal-bed methane gas producer is evidently positioned for growth.
The numbers and facts are compelling, says Stephen Hill, vice president of the company’s corporate communications operation. “China will need 200bn cubic metres of natural gas in 2015, doubling the 2008 level, according to recent remarks by a senior industrial researcher at the energy research institute under the National Development and Reform Commission, Liu Xiaoli.”
And by 2020, unconventional gas may account for 30 percent of China’s total gas output. “This estimate was stated by Jie Mingxun, president of the CBM unit at PetroChina,” continues Mr Hill. “China, which is the world’s largest polluter, wants to triple the use of gas – which has significant environmental benefits – to around 10 percent of its energy consumption by 2020.”
The industry is well subsidised by the Chinese government, who have good reason (see box-out) to ensure its a success. By 2030, it is thought that cold bed methane could provide 14 percent of China’s gas domestic supply – a staggering amount.
Early mover advantage
Green Dragon Gas was one of the first foreign companies to venture into China’s coal bed methane industry in the late 1990s. The venture increasingly appears to be paying off.
Yes, naturally, there are risks. Despite the large resource base and production potential, Chinese coal bed methane reservoirs remain technically tough to produce. Chinese coals have a high gas content but are under-saturated, and have lower permeability compared to coals in well known basins in the US or eastern Australia.
So investors clearly have plenty of reason to be excited. Randeep S Grewal, CEO of Green Dragon, says “Hong Kong is increasingly becoming a home for commodity and asset backed companies which have core operations in China or are linked to the Chinese consumer.”
Big board move
Following intensive evaluation of main board listing options, Mr Grewal says “Green Dragon believes Hong Kong offers the best market potential in the long term. The greater institutional appreciation in Hong Kong of the value of the company’s unconventional gas assets and understanding of the China country risk makes it a logical step for the company.”
This decision follows the appointment of CLSA, a leading Asian independent brokerage and investment group, to advise the company on Asian capital markets strategies. The current AIM listing is expected to be maintained following the Hong Kong move.
Green Dragon Gas has asked five selected manufacturers to quote for the supply of a drilling fleet of 25 rigs, complementing its existing drilling fleet of seven rigs. “The rigs are expected to start delivery in 2011 so as to facilitate an aggressive drilling programme in the Shizhuang South block,” says Mr Grewal.
“The rigs will be relocated to other blocks [the company has five blocks other than Shizhuang South] or to third parties following the full development of Shizhuang South. Each of these rigs will be deployed to drill SIS wells and substantially increase the drilling capacity from the current two rigs that validated this commercial technique. The company intends to make its selection of supplier prior to year end.”
Reasons to be confident
There are plenty of reasons to be confident. Just look at what big players like CNOOC are doing. It recently announced it acquired a 33.3 percent interest in Chesapeake Energy’s 600,000 acre (2,400sq km) oil and gas leasehold in the Eagle Ford Shale project in South Texas. CNOOC will pay $1.08bn cash and will fund 75 percent of Chesapeake’s share of drilling and completion costs up to the same amount.
Mr Grewal says that much of this expenditure – and that of Petrochina’s investment in Australia – is aimed at understanding the technologies to apply domestically inside China. “It shows the value of our technologies and our abilities to get results from the money we have deployed to date,” he says.
Brokers UBS estimate this will add about $3.1bn to $3.6bn to CNOOC’s capital expenditure through 2012.
Rising market share
Bernstein analyst Neil Beveridge feels confident that a confluence of factors coming together will also back players like Green Dragon. “E&P companies appear to have got the technology right,” he says. “After years of trial and error it is becoming clear that horizontal wells are the right technology which will allow commercial scale gas production. Secondly, gas prices are on the rise. Coal bed methane prices are unregulated and through innovative CNG sales strategies and local industrial demand we believe wellhead netbacks can reach prices of $7/mcf.”
China’s gas market potential is enormous – but what about supply? “Over the next 10 years Chinese gas demand will increase by 200 percent at an annual compounded growth rate of 10-15 percent to reach a total annual demand of close to 300bcm (30bcf/d) by 2020,” Mr Beveridge says. “Overall we expect gas to reach about eight percent of the energy mix by then, which although is a significant increase from current levels, is still low relative to international standards such as the US, where gas accounts for 25 percent of the energy mix.”
Price and consumption pressures
Gas price increase in regions along the Sichuan-to-East gas pipeline distribution is clearly positive news. Eight areas along the Sichuan-to-East gas pipeline distribution, including Sichuan, Chongqing, Hubei, Jiangxi, Anhui, Jiangsu, Zhejiang and Shanghai have all increased gas price since June.
This was in order to compensate the downstream sector for the wellhead gas price increases set out by the National Development and Reform Commission (NDRC) on 1 June. As an example, according to the management of Sinopec, the Sichuan-to-East gas pipeline project is projected to bring RMB20bn revenue to the company, from the sales of 12bn cubic metres of natural gas with a price of $6.3/mcf and another RMB2bn from the sales of by-products (Source: gasshow.com, 2 Sep 2010).
Macquarie argued in a recent report that ‘drive’ consumption will be replaced by gas: “We analysed the supply, demand and substitution dynamics of natural gas in China, the US, Korea and Japan,” it said. “We believe that China’s natural gas price ($6.94/mmBtu at the city-gate) unleashed from regulations will trend towards Korea and Japan prices of $12-13/mmBtu rather than towards US prices of approximately $3.65/mcf and that astute policy will prevent a collapse in prices even if gas output surges for decades; welcome to China T-Boone Pickens.”
China’s National Development and Reform Commission energy research deputy head, Junfeng Li, said in a recent forum at Cheung Kong Business School that due to supply constraint, an increase in natural gas prices is inevitable.
Mr Li also indicated that in the 12th five year plan there will be more effort put towards developing gas fired power plants. Gas fired power shares more than 30 percent of total power supply in Europe and more than 20 percent in the US, while in the People’s Republic of China it is almost none.
Confident Conoco adds its support
Conoco has now contributed $42.6m towards work on Green Dragon’s GSS block programme. This cash has principally been deployed to enhance the value of existing resources.
“We appreciate Conoco’s contribution during the past 15 months,” says Mr Grewal. “However, with the collaboration having now come to an end, I am pleased to confirm that our shareholders will now retain all rights, title and interest in our unique production sharing contract and the company will continue its exponential growth. We have now demonstrated the success of the optimum SIS technology, documented a repeated stable production profile and are expanding our drilling programme with the deployment of additional rigs.”
“These decisions position Green Dragon Gas to maintain its growth trajectory into 2011 and the years beyond,” he says, “while enhancing shareholder value with a unique and low carbon business plan, which is consistent with China’s new five year economic plan on increasing domestic production and use of gas.”
The Sinoenergy connection
As part of its overall sales strategy, Green Dragon recently bought an interest in Sinoenergy, an operator of retail CNG stations and CNG equipement manufacturer in China. The reason? Such a move gives the company access to the mid and downstream sales infrastructure within certain niche locations across inner province China – precisely where the shortages are. It also significantly expands Green Dragon’s compressed natural gas (CNG) retail technology division.
“The structured transaction involves an initial investment of approximately $35m for a minimum equity interest of 33.3 percent and could be up to 59.3 percent in the operating business,” says Mr Grewal. “Upon conclusion of the current ongoing corporate reorganisation and related approvals the precise equity interest will be concluded.”
Green Dragon Gas will determine the final equity amount. Almost $20m of the total investment was to acquire convertible bonds from funds administered by Abax Global Capital. Until the transaction is completed Green Dragon Gas has a security interest over all the assets of Sinoenergy and its parent. The company was also able to fund the acquisition from its existing cash resources.
“Green Dragon Gas has a clear vision and strategy to build a significant China coal bed methane sector upstream business complimented by a substantial gas distribution network in China superimposed by proprietary technology,” says Mr Grewal. “This acquisition provides all these ingredients synergistically.”
“This acquisition also now makes Green Dragon Gas a unique one stop shop for a comprehensive solution to gas utilisation within China’s energy mix,” he says. “It allows Green Dragon to capture the highest margin business within the gas value chain, with CNG trailers taking our coal bed methane gas production to CNG retail stations that have our CNG dispensers selling gas to cars converted by our CNG conversion kits.”
Technical advantages
– Green Dragon has a 50:50 joint venture with coal bed methane drilling specialist Mitchell Drilling Corporation, with which it has a 10 year contract for the exclusive use in China of Mitchell’s Dilation surface-to-inseam technique
– It has branched into downstream city gas distribution with a 29 percent JV with Beijing Huayou (the partner is PetroChina Kunlun Gas) to supply gas to customers in the Beijing Development Area
– Help from proprietary Dymaxion SIS technology for horizontal drilling at its GSS block lead to enhanced results in drilling productivity and efficiency of operations. For example in 2009 gas production increased by more than 125 percent on a daily basis
– China has an enormous coal reserve base which should underpin a large resource base in coal bed methane, says Bernstein analyst Neil Beveridge. China’s estimated coal bed methane reserves are similar to those of the US and Australia
– It has been aggressively adding to its distribution business in refuelling stations for fleet transportation and has locations in Beijing, Henan, Anhui, Shandong and Hubei provinces.
Why coal bed methane is important to the Chinese economy
– Coal bed methane plays an increasingly vital role in China’s energy mix. It is also a resource that is being actively promoted by the Chinese government. There are only a handful of publicly traded coal bed methane companies with plentiful amounts of acreage and established reserves – Green Dragon is considerably more advanced in the exploitation of these reserves and resources than much of the competition.
– Long-term sustainability is also very important as China is reducing its dependence on coal. To do this it must ramp up the consumption of natural gas and renewables – part of its commitment to the Kyoto agreement.
That’s why the Chinese government has also issued practical policies to support the coal bed methane industry for more than 10 years. Development and utilisation of coal bed methane can not only control levels of coal mine gas, but also make full use of clean energy.
