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A potential China play for the risk-taking small-cap investor is China’s coal bed methane [CBM] industry. There are a handful of publicly traded foreign firms that have been actively making inroads in the sector that could prove to make some big money in the future.

The CBM industry is involved in the capturing of methane gas that seeps out of coal deposits, which is then processed into natural gas. The sector has been growing steadily in the United States, Canada and Australia for the past few years, with China as the next frontier. China is particularly attractive because of its massive coal reserves – estimated to be over 1 trillion tons, of which 189 billion tons can be used. As a result, coal currently accounts for close to 70% of China’s energy production.

But with energy demand surging and its skies some of the most polluted in the world, China must find a way to utilize its coal - one of the dirtiest energy sources - in a more efficient and clean manner. In fact, scientists say that China has now surpassed the United States as the world’s largest greenhouse gas emitter. These developments bring opportunity for CBM. By capturing the methane, a potent greenhouse gas, that is emitted from the ground and also released from coal mines, which is known as coal mine methane [CMM], China could theoretically produce natural gas. The country is estimated to have up to 36.8 trillion cubic meters of methane in its coal deposits and mines, most of it in western China.

With such potential benefits, Beijing has made the development of CBM one of its top energy priorities. The government hopes that by 2010, methane gas production from CBM and CMM will reach 10 billion cubic meters. Last year, by contrast, CBM gas production was less than 100 million cubic meters, so there is much room for growth. To boost the sector, the government has promised subsidies and new rules to encourage investment, especially foreign money. It is also a sector that requires foreign imports because China lacks the sufficient technology to efficiently drill and capture the gas. In fact, during the Strategic Economic Summit with Washington in late May, Beijing pledged to jointly develop 15 CBM projects with U.S.-made technology, which included equipment from Caterpillar Inc. (NYSE: CAT).

For investors seeking to ride this potential, take a look at Far East Energy Corp. (OTCQB:FEEC) an U.S. company whose CEO and President, Michael R. McElwrath, is a former acting assistant Secretary of Energy during the first Bush administration. The firm has been in China since 2000 and is actively exploring, developing, producing and selling CBM in China. From 2005, it has invested more than $20 million in CBM projects in China. The company in early June obtained extensions by the Chinese government for two of its pilot exploration contracts in China, which allows it to step up its drilling and expansion. FEEC’s stock sells for around $1.50 a share with an impressive year-to-date increase of close to 65%. Its 52-week high is $1.92.

Another company heavily involved is the Canadian-listed Pacific Asia China Energy Inc. (OTC:PCEEF). In June, the company announced it has begun drilling in its pilot CBM project in southwestern Guizhou province. Also in the same month, Pacific Asia China Energy announced it had started to receive payments from its share of an $8.3-million degasification project in northwestern Ningxia province. Its stock currently trades at around C$0.50 a share. However, it is down over 8.5% year to date, and is way below its 52-week high of C$1.04 a share.

What are the caveats? China’s energy sector has always been risky for foreign firms because it is highly regulated and fragmented. The coal industry is particularly tough because it is controlled by the local governments, mostly in China’s central and western regions, which tend to be even more bureaucratic and corrupt. Low natural gas prices are also a problem, which makes current investment returns on CBM less than ideal. Another consideration is the lack of access to local pipelines to transport the gas. The approval process for CBM projects is lengthy and costly, with the granted exploring periods short. For these reasons CBM has been slow to take off, with much of the methane continuing to be released into the air without capture.

However, improvements are slowly taking place. Beijing has raising consumer natural gas prices annually by 10% and is also considering reducing certain extraction- and value-added taxes. In addition, the government is stepping up its construction of natural gas pipelines. If these measures are successful, CBM could be the next industry seeping with profits in the next few years.

Disclosure: none

Source: Benefit From China's Coal Bed Methane Sector