Institutions Chasing CBM Opportunities in China

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 |  Includes: AA, CAF, FEECQ, UBS, X
by: James Finch

The retail investor many not be paying attention, but institutional investors are slowly gaining significant holdings in China’s energy crisis.

Earlier this month, tiny Hong-Kong listed Zhongyu Gas Holdings (Hong Kong Stock Code: 8070) announced a number of ‘leading institutions’ had participated in its latest round of financings to develop the company’s coalbed methane [CBM] resources in China.

Perry Capital LLC led the financing. With about US$14 billion under management, the US$78 million, which the New York-based investment firm raised in late May, was a drop in!
the proverbial bucket.

A few days later, Morgan Stanley Asia (NYSE:CAF) stepped in with five institutional investors announcing the completion of a convertible bond financing for the same company.

In an early June news release, Zhongyu Gas Holdings was delighted to ‘highlight the participation of a number of large institutional investors’ in the company’s recent financings. The company also noted that Perry Capital has now invested in more than five percent of this CBM gas company. They also pointed out, "Perry Capital has made investments globally in the energy sector, including companies with CBM operations.”

About the same time, one of the CBM companies we’ve been following, subsequent to an IPO on London’s AIM exchange announced it had raised US$50 million through an unnamed institutional investor. Green Dragon Gas Ltd issued a zero-coupon convertible note, which matures in May 2009, and is convertible at US$5.56/share. UBS (NYSE:UBS) and Quam Capital acted as facilitators in this financing.

Green Dragon’s chief executive Randeep Grewal explained this would help the company ‘accelerate its growth plans for this year.’ Based upon the company’s coalbed methane drilling success, completed earlier this year, Green Dragon was selected as a featured CBM company in StockInterview’s “Investing in China’s Energy Crisis.”

As of March 31st, Far East Energy Corp (FEEC.OB) reported that institutions held 13 percent of the company’s float. Mutual funds include Heartland Value Fund, Dreyfus Premier Greater China Fund and The China Fund.

Canada’s leading natural resource investment firm, Sprott Asset Management – with amazing investing success stories in uranium and molybdenum mining stocks – invested in Pacific Asia China Energy (OTC:PCEEF), which is not only developing its CBM project in China, but also includes a drilling company subsidiary to help degasify China’s coal mines.

Why are institutional investors rushing to buy into foreign companies with CBM production-sharing contracts in China?

China has mobilized a national campaign to utilize CBM gas in every way possible in order to clean up its act – with regards to both air pollution and oil/coal dependence.

Since mid 2006, the National Development and Reform Commission [NDRC] has hammered away to prioritize CBM gas in the energy mix.

In an April 2007 memorandum, China’s Ministry of Finance began circulating to the country’s provinces, autonomous regions and municipalities under the Central Government’s control for opinions on subsidizing the development and utilization of CBM gas. Translated into English, the introduction announced:

At present, the market of CBM development and utilization is not mature with high cost of development and utilization and bottleneck in technology. The Ministry of Finance decided to allocate appropriate subsidies to CBM civil gas in accordance with the spirit of ‘Special Meeting Summary for Study of Comprehensive Treatment and Utilization of Coal Mine Gas’ (Guoyue (2007) No. 19) by the State Council General Office so as to encourage CBM development and utilization.

This also includes the companies moving their coalbed methane projects forward. The memorandum also stated, “The enterprise which engages in CBM development is eligible to enjoy the financial subsidy…"

Government subsidies are the vehicles which cause energy-related projects to soar. The recently re-emerging U.S. nuclear renaissance can trace its beginnings to congressional subsidies. So can the revival of renewable energy sources, such as windmill power.

After the U.S. energy crisis of the 1970s, government subsidies launched the U.S. development of coalbed methane resources in Alabama, New Mexico and Wyoming. Coalbed methane gas now provides about 8 percent of the total U.S. natural gas production.

China is aiming for 10 percent of the country’s natural gas consumption by 2011 – just from coalbed methane gas. But there are transition problems which require resolution to achieve this goal.

Just for the natural gas distribution business in China, Hong Kong and Chinese companies are now on track to raise about $500 billion in capital. Privately held Sino Cheers, which is registered in Hong Kong, hopes to construct an 800-ton/day LNG plant in Shanxi. The company has adequate capital and technology, but can not acquire enough CBM or natural gas to proceed.

This comes at a time when China is zealously trying to reduce energy consumption per unit of gross domestic product. Because of China’s reliance upon coal-fired plants, and its double-digit GDP growth, the country reportedly produced 6,200 metric tons of CO2 in 2006, overcoming the Unites States as the world’s largest producer of carbon dioxide.

In response, China has begun a series of energy-slashing programs. One includes setting temperatures in public buildings at no higher than 79 degrees Fahrenheit. This comes at particularly bad time – earlier this week, electricity consumption from air conditioning use in Beijing was the highest in history and nearly matched the city’s maximum capacity.

Another step is a program to switch over Beijing’s electricity production to natural and CBM gas in time for the 2008 Olympiad. China’s Central Government wants to dress up Beijing and end the stigma of being known as one of the most polluted cities in the world. Some suspect CBM gas may be used to light up the Olympic flame.

As a result, CBM, natural gas and LNG are very ‘hot' right now, according to one of our sources in China.

And speaking of hot, China is experiencing a blistering heat wave in June. Just as we find central Romania and the Balkans suffering an unusually hot month, temperatures in China’s ‘hottest area, western Turpan in the country’s Xinjiang region hit 112 degrees Fahrenheit this week. This could put China at the risk of rolling blackouts during the heated summer months.

This could force the Chinese to accelerate their crossover to increased natural gas consumption.

By comparison, natural gas prices in the U.S. have become a headache for the Industrial Energy Consumers of America [IECA]. The trade organization represents major manufacturers relying upon natural gas and other energy sources, and it includes Abbot Laboratories, Coors Brewing, Dow Corning, Tyson Foods and U.S. Steel (NYSE:X) among its many members. Natural gas is used during the production or manufacturing of fertilizer, metals, chemicals and consumables.

The ICEA president recently argued natural gas prices have ‘increased an incredible 156 percent since May 2000.’ He believes natural gas prices could rise another 35 percent by January while gasoline prices could drop by 20 percent. The Federal Energy Regulatory Commission [FERC] announced in its Summer Energy Market Outlook that electricity prices could increase by 30 percent. ICEA blames natural gas and electricity price increases are rising because of the U.S. reliance upon gas-fired electric generation. Since 1996, electricity generation by natural gas has jumped by nearly 75 percent.

ICEA pointed out that while natural gas provides 20 percent of America’s electricity, this fuel accounts for about 55 percent of the electric industry’s fuel expense – US$50 billion out of $91 billion!

But the U.S. has also increased natural gas imports and is relying upon the Middle East for natural gas supplies – transported by LNG from Egypt, Oman and elsewhere. China's ravenous energy appetite has already struck Australia. Alcoa (NYSE:AA) has complained of a natural gas shortage in Australia, where 13 percent of the world’s alumina is produced in three western Australian refineries. Metals and chemical sectors rely upon natural gas during the manufacturing process. China sewed up a 25-year supply from one of Australia’s largest natural gas reserves – the North West Shelf – in order to continue powering the country’s industrial sector.

One report, which we obtained, indicates that Chinese coal mining companies and Coal Mining Bureaus are trying to circumvent involvement with China United Coalbed Methane [CUCBM] in developing coalbed methane projects.

This strategy involves de-gasifying the methane from coal mines and selling the CBM gas directly to the local gas distribution companies. That is how energy-starved China has become.

For now, foreign institutional investors are feasting on the potential opportunities China’s vast coal fields provide. The Central Government’s insistence on intensifying degasification projects open doors for those with drill rigs.

Over the past year, we have observed the emergence of one company’s subsidiary proceed with the launch of its degasification services. In mid February, the joint venture of Pacific Asia China Energy [PACE] and Australia’s Mitchell Drilling signed the first coal mine degasification project with Shenhua Group’s Baijigou coal mine in Ningxia province. According to PACE vice president Steven Khan told us that both Dymaxion® drill rigs are currently degasifying this coal mine. He pointed out, “The US$4.5 million contract is a major win for us. We now have a window of opportunity to become a leading degasification drilling company in addition to developing our CBM concessions. The challenge is to finance and build enough rigs to meet the task.”

We asked Khan for his reaction to the recent spate of institutional financings for CBM companies. “The capital raised and concurrent investment by Perry Capital into Zhongyu Gas for their CBM projects further demonstrates the enormous opportunities in CBM development in China.

Julie Ickes co-wrote this article.