Shares digital

A trip to China throws light on the development of alternative fuel sources

From oil to gas

Tom Sieber

Shares’ last look at the issue of energy security (6 November) acknowledged the fact crude oil remains virtually the only game in town, at least in terms of providing the energy to get us from A to B. But following a visit to assess the operations of coal bed methane (CBM) specialist Green Dragon Gas (GDG:AIM), which is selling compressed natural gas (CNG) at the pumps to motorists in China, we can now re-examine some ‘unconventional fuels’ and other solutions that may eventually replace petroleum.

Across the globe a number of potential candidates are being researched and exploited, though typically companies involved in developing these solutions have made poor investments. Ethanol and other biofuels are proving particularly problematic, both commercially and environmentally, with one of the largest ethanol operators in the US VeraSun recently declaring itself bankrupt. Other options such as oil & gas shale and coal-to-liquids remain relatively unproven. The case for investment in these alternatives has not been helped by the falling oil price which has made the

economics of such projects look much less attractive.

Gas alternatives

The use of CNG or liquefied natural gas (LNG) to power vehicles is proving particularly popular in India and China, mainly because it is cheaper and cleaner than petroleum. In Beijing alone, 20,000 taxis, 30,000 buses, and 2,000 special-purpose vehicles run on natural gas and, over the next three years, the city’s leaders expect these numbers to double.

Green Dragon Gas is attempting to tap into that demand. The share price has fallen nearly 40% since June to less than $6 and now could be a good time to invest in the story. House broker Evolution Securities highlighted the disparity between Green Dragon’s valuation and that of Australian CBM operators such as Origin Energy, when the Chinese firm’s shares were at $8. ‘Our valuation of Green Dragon’s assets indicates a valuation of its reserves of around $0.20 per mcf compared with $1.88 per mcf offered by ConocoPhillips for Origin’s CBM assets in Australia. Even discounting for lower gas prices in China, the less developed nature of the assets and other factors, a valuation of only 10% of the Conoco deal looks far

too cheap.’

The Green Dragon business is more than a decade in the making but the first signs its strategy will be successful are starting to emerge. Chief executive Randeep Grewal believes the world is on the cusp of the ‘gas’ age to replace the oil age of the past 150 years and he is attempting to transform the £400 million market cap into a vertically integrated gas supplier with involvement in the production, marketing and sale of

the commodity.

A trip to the company’s Shizhuang South block in Shanxi province, central China, helped to give Shares a better understanding of how this is working in practice.

Green Dragon has three main options in terms of selling its output. It can either be converted to CNG, LNG or piped natural

gas (PNG).

Shizhuang South is the first of the company’s six blocks to go into full scale production. The basic model is relatively straightforward. Initially the company drills into the coal to extract the methane. This gas is then piped to a central processing facility where it is compressed and loaded on to a truck as CNG, before being transported 220 kilometres by road to Zhengzhou, the capital of Henan, China’s most populous state. It is then sold to motorists from a CNG retail station.

The group picked up four of these stations as part of the acquisition of Zhengzhou Nanhai Gas in August. At present only the one in Zhengzhou – a city more than three times the size of Birmingham – is up and running but by the middle of next year Green Dragon hopes to have stations at Zhengzhou airport and in nearby Zinzheng and Jiyan on stream.

The price the group gets for its gas by selling it in this way is attractive: $13 per mcf compared with a global gas price of $6.50. Grewal is at pains to point out this is a good deal for the motorist as well, who pays around 40% less than for ordinary fuel and forks out just $250 for the piece of kit that enables a vehicle to run on CNG.

A drilling division last year, Greka Technical Services, was launched by Green Dragon last year and the unit acquired five state-of-the-art rigs from the US. These truck-mounted rigs can be mobilised more quickly than traditional rigs and Grewal hopes they will help reduce the time it takes to drill a well from around 40 days using Chinese teams and equipment to closer to ten.

Coal bed methane operators drill huge numbers of wells, a lot more than more traditional oil & gas explorers, and Green Dragon has drilled 139 in just the past 12 months. Increasing efficiency in this area is therefore crucial.

The infrastructure in place in this part of China is impressive and most of the journey from Zhengzhou to the Shizhuang South block is on a four-lane highway that even circumvents the Taihang mountains straddling the border between Henan and Shanxi

Green Dragon is running a trial on an impressive system that allows it to monitor activities on the ground in Shizhuang South and at the group’s active gas station in the centre of Zhengzhou from its office in the city. The pictures are transmitted by a physical cable running all the way from the facility, and even though it costs around $5,000 to set up the system on one well Grewal eventually expects the technology to be used across the business. ‘It means I can have the guys in the office making the big decisions rather than having to micro-manage things out there on the ground.’

At present Green Dragon is still in the early stages of realising its potential. It remains loss-making and the shares are relatively illiquid, trading on a bid-offer spread of around 13%. But if it can repeat the success it has had in Shizhuang South on its five other blocks, the future looks bright for the company.

Not cooking with gas

The same cannot be said for fellow junior market firm and ethanol producer GTL Resources (GTL:AIM), which is valued by the market at just £6 million, having fallen 80% this year down to 19.5p. Whether or not ethanol producers are to blame for the global food crisis the reputation of the industry, a large consumer of crops such as corn and sugar cane, has taken a bashing. This may even threaten the government inducements it currently enjoys. The spiralling cost of corn earlier in the summer also put margins under significant pressure.

GTL, which is based mainly in the US, expects to report an underlying pre-tax loss for the first half of its financial year due to soft industry margins, which it admits remain an issue. In addition to the operational deficit, GTL recently revealed it had incurred $4 million in losses on corn positions held against October to December delivery due to the recent dramatic declines in corn prices.

Australia-based Spitfire Oil (SRO:AIM) has also been a dismal performer, plunging 90% since its flotation a year ago to 10.5p. The shares of the £4.5 million cap company, which is developing a project in Salmon Gums, Western Australia to turn lignite into fuel oil, are also extremely illiquid. Oil’s fall from $147 a barrel to barely $50 makes it more difficult for the numbers surrounding the development to stack up, although Australia-listed peer Blackham Resources recently produced a scoping study on its Scadden project, which is similar to Salmon Gums, suggesting it would be economically and technically viable at an oil price of around $47 a barrel.

The weakness in crude has also made oil & gas shale projects look less attractive. Xtract Energy (XTR:AIM), an energy investments company, based in Europe, the US and Australia, has been working to develop a proprietary technology that will make the process of extracting oil from shale less expensive and less damaging to the environment. This is still in the early stages and the share price has fallen by 80% since January to just 1.1p. The £8.5 million market cap recently reported a 90% drop in profits from £9.7 million to £955,000 and the company’s accompanying outlook statement was less than equivocal saying it had a ‘reasonable expectation that the group will be able to continue as a going concern’.

At present it appears LNG and CNG are the most feasible alternatives to oil as a means of facilitating transportation and this fact is reflected in their ready adoption in the two most energy-hungry countries in the world – India and China. n