Green Dragon Gas looks to motor ahead fast

Currently valued at £1.2 billion Green Dragon Gas (LON:GDG) is one of AIMs largest firms. But while its value already eclipses many others in the oil and gas sector one can’t really compare the stock to any peers. 

What makes it unique against its peers? Well, first of all investors are only just waking up to the potential of its specialism, coal bed methane (CBM). The fuel source is one of the least discussed unconventional hydrocarbons, indeed it could be described as shale’s less famous, but cleaner cousin. 

If you are unfamiliar with this particular type of hydrocarbon CBM is a type of natural gas that was trapped when coal seams formed millions of years ago. In certain parts of the world it is abundant but getting it out of the ground is a complicated business.

Another vital aspect of GDG is the sheer scale of its gas reserve. In December 2010 a reserves report put the group proved and probable (2P) reserves at 273 billion cubic feet, which was valued at US$1.5 billion at that time. Beyond that it has 2.6 trillion cubic feet of net proven, probable and possible (3P) reserves,valued at US$12.3 billion.

While these numbers are significant, as those with CBM knowledge will know, finding the gas is only a small part of the equation – particularly in China where coal seams are brittle and highly faulted. 

Indeed the geological complexities of China’s coal beds had posed an almost un-solvable puzzle. But in 2008, Green Dragon – through its recently spun-out drilling division Greka - cracked it with some clever technology that was adapted to suit the terrain. 

Now with Greka Drilling’s help Green Dragon is about to embark on a huge well development programme to unlock this immense potential. The US$250 million capex programme is targeting an 18-fold uplift in production. 

Is “SIS” Methodology the final piece in the puzzle?  

Up until now the Green Dragon story has really been about adapting the technology, as the group developed a way to achieve commercial CBM production from its vast in-place reserves.

In certain parts of China CBM is abundant. However, until recently it was almost impossible to tap commercially.

Explaining the origins of Greka’s surface-in-steam (SIS) methodology Grewal said: “Originally we were looking at it scientifically, asking ourselves how we can commercialise the gas that’s in these tight, highly faulted coal bed methane rocks?”

“Quite simply no else could do it then, the technology just wasn’t available.  The Chinese service companies supporting Petrochina, Sinopec and CNPC had been working on ways to solve this problem unsuccessfully for two decades. 

Faced with no other option, Green Dragon went down the path of developing its own drilling business, with specialised proprietary technology.

The result was the Greka Drilling SIS methodology, which combines both horizontal and vertical well sections, to provide access to a larger contact area, which in turn leads to greater gas flows. Once drilled, large volumes of water are injected in the well, then as the water is subsequently extracted a change in pressure draws out the gas from the coal seams.

A similar technique, known as Dymaxion, was developed to extract CBM in Australia however it needed to be adapted to deal with the China’s more brittle and highly faulted coal seams.

“When we successfully drilled the first well using SIS, back in 2008, right away we knew it was one of those eureka moments,” Grewal said. “We succeeded where other companies had failed.”

Now the SIS methodology is at the centre of GDG’s ambitious US$250 million capex programme. 

This expansion aims to give Green Dragon an eighteen-fold uplift in annual production, from 1.3 to at least 18 billion cubic feet of gas in just two years.  Green Dragon’s recently spun-out division, Greka Drilling has been contracted to drill the 100-plus wells required to achieve this target. 

Crucially both Greka and Green Dragon are now awaiting the delivery of a new-generation of drill rigs that were specifically designed by Greka’s engineers in conjunction with the Italian manufacturer for SIS drilling.

The first rig is expected to be shipped in July and commissioned in September. After that the drilling campaign will ramp up very quickly indeed. GDG is expecting to take on a rig each week through the autumn, until the first 25 have been delivered. 

Poised for a massive eighteen-fold production uplift

Last year GDG produced 1.3 billion cubic feet of CBM, beating its original 1 billion cubic feet target (bcf) target. And Grewal hopes that the next, albeit much bigger, step-up will follow a similar pattern. Indeed the GDG boss hinted at the possibility that his firm could ‘under-promise, and over deliver’ again.

“We are very comfortable with our 18 bcf target, which we plan to achieve in just two years through the US$250 million capex programme.

“Personally I think our gas production could actually exceed this target.”

He added: “On a daily basis we’re telling analysts that we expect each of our wells to come online at around 300,000 to 350,000 cubic feet a day.

“That is a big CBM well. But our first well drilled with this technology over 3 years ago, GSS008, is now producing more than 450,000 cubic feet a day.

“Basically my point is we are asking the analysts to model our stock, and our forecasts, using what we see as a conservative number.”

Whether its expectations are conservative or not, an 18-fold step up in production will clearly be an incredible achievement for any company, anywhere in the world.

Gearing up to handle a step-change in capacity 

Unlike most of AIM’s energy stocks, Green Dragon’s operations don’t stop there. 

‘Vertical integration’ is one of those awful corporate phrases that quickly become meaningless, uttered in the same breath as ‘blue-sky thinking’ and ‘optionality’, it is rarely used appropriately. 

But in Green Dragon’s case it really is a significant point. The group actually is vertically integrated, through its midstream processing operation - it converts the methane gas into compressed natural gas (CNG), then through its own distribution network in transports the processed fuel to its end markets.

Then, through its own retail garages it sells this CNG, from the pump, to customers.

While the 100-plus well drill programme could be described as ambitious, the scale of GDG’s plans is at least matched by its plans further downstream.

“While the emphasis has previously been on technology, now all our people are focussing on ways to increase productivity, efficiency and land utilization. We’re securing essential infrastructure things like compressors, power supplies, pretty much everything involved in rolling out a major manufacturing operation,” Grewal said.

“Over the next two years we really want to gear-up our downstream operations so that we’re ready in 2013.

“Our aim is to grow our downstream capacity so that we can handle at least 75 – 80 percent of that 18 bcf annual production.

“So we’re really busy in that regard.”

Fuelling the wheels of the People’s Republic

To properly get to grips with the Green Dragon story it is really important that European investors appreciate some of the dynamics of China’s transport fuel market. Even the most ill-informed layman is aware of the enormous growth in China, and its seemingly bottomless thirst for fuel.

China is believed to consume over nine million barrels of oil per day, and crucially it cannot satisfy this demand by itself. The People’s Republic imports nearly half of it oil consumption.

To tackle this dependency on international supply the China is doing its utmost to exploit its abundant, but unconventional, fuel sources like CBM.

To this end China’s government is helping companies, like Green Dragon, to develop retail demand among end users. Specifically in this case it is subsidising a new generation of hybrid cars that can run on compressed gas.

“The economy is growing exponentially, year after year. And the number of cars coming on stream is massive. 

There’s so much new transport in China, lots of cars and lots of buses, but there is not enough petrol or diesel,” Grewal emphasised.

“For the government the logical thing to do has been to economically incentivise people to drive vehicles on natural gas.”

He added: “Right now in China, you can buy a car and upgrade to a gas hybrid for about 4,500RMB, which is about US$250. This gives the owner an option rather than just depending on one type of fuel.”

“So you can still drive your car on traditional fuel like petrol or diesel. Or if there is a CNG supply available you can fill up the car with our gas, which is as much as 90 percent cleaner and about 30 percent cheaper.”

Grewal explained that, where its supply exists, Green Dragon is achieving a particularly high level of penetration in end-markets, particularly with commercial vehicles. 

“Where we are supplying CNG, more than 75 – 80 percent of local taxis are hybrids. In fact at our stations it is a common sight to see taxis lined up waiting for the gas,” he said.

“We are selling gas today at around US$15 for a thousand cubic feet. As high as that might be in global terms, it is still about 25 – 30 percent cheaper than fuelling the car with petrol to travel the same distance.”

As well as stimulating its end-markets the Chinese government is also subsidising Green Dargon directly. Speaking about the government’s support, Grewal said: “We are very fortunate that the Chinese central government has provided pragmatic financial incentives for businesses to succeed.

“What they’re essentially saying to us is: we know you’ve got it, we know you can get it out of the ground, now here’s a few more dollars, per thousand cubic feet, to get this industry going a lot faster.”

Capex programme is largely funded

Financially, Green Dragon began 2011 in a good position, after producing 1.3bcf and raising US$200 million in 2010.

“We’re sitting on a very good balance sheet,” Grewal explained.

“We finished 2010 with more than US$140 million in cash, so we’re in a very good place from a cash standpoint. We have raised additional cash early in 2011 and really we have no debt but for a convertible bond. So looking forward we see ourselves in a very comfortable place.

Grewal emphasised that, from a financial perspective, the plan is to get the drill programme going, secure the additional production and then sell the gas. Green Dragon can then create the earnings (EBITDA) growth before arranging some local Chinese debt to continue the group’s rapid expansion.

“We have funding options through debt, he stressed. That would be the beginning of a real balance sheet that to date has relied only on equity”.