Gas from the Coals of China

Abstract: Small, launched-for-purpose companies could expand exponentially by tackling the challenge of producing coalbed methane in the world's most populous country.

Analysis: Ever taken a look at a detailed map of China? No? How about a map of China, period? Me neither, at least not until last week.

Admit it: China's still a country about which most of us know little, even with good geography grades in school. Learning about China is challenging on many levels. For one thing, most of the English versions of Chinese map references -- provinces, cities, rivers, and so on -- are hard to pronounce, much less spell. And mapmakers and dictionaries all have different spellings of the same place words. Take the capital city, for starters. Once, it was Pekin. After that, Peking. Now, it's Beijing. You get the idea.

But more major and independent oil companies might consider orienting themselves (no pun intended) a bit more to China's geography, as well as to her geology. Why? Because the government of the Peoples (see -- no apostrophe) Republic of China (PRC) hopes to create the most active coalbed methane (CBM) exploration and production (E&P) hub on the globe. And they're counting on overseas companies to help.

Even though China has produced oil for centuries, modern-era E&P has been less than dazzling. Sure, there are a few big oil fields, particularly in the southern provinces (after all, the birth of Royal Dutch/Shell in the early 1900s was based on "oil for the lamps of China"). But even today, China's oil output is close to dead last among producing nations.

Finding today's most attractive fuel -- natural gas, particularly of the conventional kind -- in China has been less than fruitful, as well. Today, China buys most of her gas from Russia, and is building the infrastructure needed to pipe imported liquid natural gas (LNG) from port cities to the interior, but chiefly for fueling an incipient chemicals industry.

Meanwhile, over the eons, the Chinese have warmed their hearths and fueled their factories chiefly with coal. Almost limitless domestic supplies of it have fed and clothed China's people since before Confucius was a pup, and have powered most of her up-by-the-slipper-straps industrial growth to this day. Hands down, China is the largest coal producing -- and consuming -- country in the world.

However, during the past 20 years, the Chinese economy has grown fivefold, with personal incomes having quadrupled and 270 million Chinese having reached what we'd call middle-class status in the U.S. What's more, China now accounts, some say, for about 33 percent of all foreign direct investments. That's more even than the U.S. or the U.K.

But a chiefly coal-fueled economy in the 21st century puts China in a tight spot when it comes to real growth in the global market. For one thing, she hopes to be accepted into the World Trade Organization (WTO). But that means she needs to change to more acceptable fuels, since WTO clean air standards are pretty inflexible.

The chief benefit of China's coal resource is that most of it is highly methane-charged. That's also one of its chief problems. Probably, there have been more tragic explosions in Chinese coal mines than anywhere else. To prevent them, China allows some 6 billion cu. m. of coal mine methane a year to be emitted into the atmosphere. That may cut down on mine blasts, but given that methane is about 30 times more of a greenhouse gas than carbon dioxide, world governments -- and trading organizations -- are hell-bent on stopping such free emissions pronto, wherever the source. And then, of course, there's the lingering effect of the Kyoto Protocol, which is aimed primarily at CO2 emissions, a major by-product of coal combustion.

But thanks in part to the birth and development of the U.S. CBM industry, China sees almost geometric growth in CBM production as a way to satisfy safety and environmental problems while boosting domestic natural gas supplies for Chinese industries, workplaces, and dwellings.

In 1996, to speed up CBM development, the central government created the China United Coalbed Methane Co. (CUCBM) as a high-level organization charged with inviting overseas companies to China for CBM co-development. There's been a learning curve since, and CUCBM-sanctioned development plans by several major and independent companies may have started with a bang, but they got bogged down in an approvals process that trickles down through oh-so-many territorial, provincial, 'autonomous regional,' and local governments, as well as myriad sociopolitical organizations. To top that off, a number of industrial groups, including Chinese coal mining interests are themselves gauging CBM prospects, as well.

Nevertheless, in the mid-1990s, BP -- along with Texaco and Phillips Petroleum before their mergers -- struck CBM exploration deals with CUCBM valued at many hundreds of millions of dollars. However, those initiatives eventually decelerated for many of the aforementioned reasons. And the Chevron-Texaco and Phillips-Conoco mergers probably have delayed the latter two deals even more, since the new ChevronTexaco and ConocoPhillips currently seem to be concentrating on potentially big oil projects in the Bohai Bay and South China Sea areas.

A similar outcome has befallen smaller CBM development deals involving independent companies, including a few based in the U.S. Nevertheless, those that have proceeded at a measurable pace constitute mostly pilot projects.

In one sense, a Chinese province with vast CBM potential -- and there are a passel of them -- is much like the northeastern U.S. was back in the 1860s, when a certain Captain Drake drilled an oil well in Pennsylvania to meet regional demand. That, of course, set the stage for the Petroleum Age and a worldwide market based on petroleum. But in modern China, a government that for decades mistrusted the very idea of free enterprise now protects its own nascent entrepreneurs by very closely restraining overseas companies from developing partnerships that may appear to infringe on Chinese firms' development.

Nevertheless, there are signs that the pressure applied by the central authority in favor of CBM development is making it less troublesome, politically and economically, for foreign entrants. Since 1990, more than 30 coal areas of China have been the scene of CBM drilling, with more than 150 wells completed, mostly to obtain reservoir and production data. Even some industrial-scale CBM production has been drawn in several provinces north and east of Beijing.

One Houston-based company, Far East Energy Corp. (FEEC), formed in 1999 specifically to develop Chinese CBM, has gained a firm foothold for doing just that in two areas of Yunnan Province, and awaits ratification of a similar deal in a third area, located in Guizhou Province. Both provinces are in south-central China (if you superimposed a map of the U.S. over one of China, those provinces would lie on a plane about equal to that of Oklahoma, Arkansas, and Missouri).

According to Chris Jackson, FEEC's corporate development vice president, the company's Yunnan Province production-sharing contract (FEEC with 60 percent interest and CUCBM with 40 percent) covers a 264,897-ac. (1,072-sq. km.) block near Quijing city. It was ratified in mid-December 2002 at a signing ceremony in Beijing. Far East Energy is committed to drill five exploration and eight pilot development wells during the next three years. The two Yunnan PSC areas overlie estimated methane reserves of more than 4.9 trillion cu. ft. (140 billion cu. m.), Jackson said. That's a bunch of methane, folks.

Oddly enough, CBM production from the Yunnan properties probably would be used chiefly as feedstock for ammonia and fertilizer plants and for production of methanol and formaldehyde, with industrial and residential heating and power generation as secondary markets, noted Jackson. The people of Yunnan Province (Yunannians?) apparently want to shine in petrochemicals.

In Guizhou Province, immediately to the northeast of Yunnan, FEEC has a PSC covering 29,653 ac. (120 sq. km.) over six coal mines whose seams hold an estimated 900 billion cu. ft. of methane. The PSC -- signed with Panjiang Coal-Electricity Group, southern China's largest coal mining company -- is overseen by CUCBM. Far East Energy will pay Panjiang the equivalent of $3.3 million over a three-year period for the right to develop the CBM. Panjiang will use the money to support pipeline and infrastructure costs to deliver gas for local residential use. Far East Energy will pay for the drilling, using mainly Chinese drilling contractors.

According to Jackson, a key to success in Chinese operations is having people on board who know the ins and outs of navigating through the country's multiple layers of government. The company, in fact, was not chartered until two years after the principals involved already had set up negotiations with CUCBM, he said.

In addition to specialists in a number of CBM drilling and production, facilities construction, and pipeline disciplines, the FEEC management team boasts the expertise and familiarity with Chinese business practices of several executives. These individuals, he said, are vital to successful Chinese operations.

"Working in the Chinese CBM arena is not for every independent producer," Jackson said. "Unless a company is willing to start from the ground up, find somebody with extensive experience in dealing with the Chinese bureaucracy, and can be assured of free transfer of finances in to and out of the country, they may find the China CBM experience difficult and frustrating. But if they're able to accomplish these things, among many others, they could find it rewarding."

Far East Energy is not completely without U.S. operations, however. Recent acquisition of shallow gas properties in Montana with recovery potential of up to 225 billion cu. ft. promises to provide early production revenues once drilling gets underway, which Jackson said will occur before the end of this quarter. The area has access to nearby pipelines with available capacity, he added. Production revenues are expected to begin by the end of the year. That income would be reinvested in FEEC's Chinese operations. Meanwhile, the company is engaged in its second round of private financing to raise additional operating capital. Having issued an IPO in 2002, FEEC's shares currently are traded on the OTC exchange.

But FEEC is not the only U.S. independent engaged in China CBM. Earlier this month, New York-based Greka Energy Corp. signed four PSCs with CUCBM for developing coalbed methane in both Jiangxi and Anhui provinces (about even with West Virginia and Ohio on the aforementioned superimposed map). The combined total contract area is about 1.7 million ac. (6,600 sq. km.), with estimated CBM reserves of some 34.5 trillion cu. ft.

Greka, a vertically integrated independent company with production and refining operations in California, expects to drill one well in Jiangxi Province this year.

Both companies are aiming at high-flying goals. However, they could represent a pioneer effort that, if successful, might make them much larger companies. And, of course, success also might make companies like them exceedingly attractive to larger companies, many of whom have not yet even considered what undoubtedly is the coming CBM boom in China.