TORONTO (ResourceInvestor.com) -- As the largest untapped natural gas opportunity in North America, coal bed methane (CBM) in western Canada has created a buzz among investors. Yet the results to date are not as encouraging as the hype would otherwise have us believe.
CBM is created during the coalification process as methane, the main compound in natural gas, becomes trapped in the molecular structure of the rock. In contrast, conventional natural gas is stored in the pore space between individual minerals of the reservoir rock. As a result, coal is able to contain up to five times the volume of gas than that found in conventional reservoir rock such as sandstone.
CBM development is more pronounced in the United States, mostly as a result of generous tax incentives, and accounts for close to 10% of all natural gas produced, or 5 billion cubic feet per day. In contrast, the industry is still in its infancy in Canada.
The National Energy Board had expected production to quadruple to 400 million cubic feet per day by 2006. Although even if this lofty goal is reached, it will represent only about 2% of all the natural gas produced in Canada.
The Petroleum Services Association of Canada has predicted over 24,000 natural gas wells will be drilled in 2005, up from 22,160 in 2004. The entire gain is a result of the predicted increase in drilling for CBM, accounting for one of every eight wells, compared with one of every 20 wells last year.
Most geologists believe there is at least as much CBM as the approximated 56 trillion cubic feet in proven reserves of conventional gas. In a report released in October 2003 by the Alberta Geological Survey, the natural gas reserves thought to be held within the various coal formations in the province ranged in size from 100 to 550 trillion cubic feet.
The three main coals being explored are the Ardley coal zone, the Horseshoe Canyon formation and the Mannville group. Whether such a huge reserve exists, and if it can be extracted at a profit, is yet to be determined.
One potential drawback is the presence of water. Coal can act as an aquifer when its naturally occurring fractures, called cleats, become saturated with water. Releasing the CBM in these coals requires pumping water out of the deposit. Once the pressure is low enough, gas begins to ooze out of the coal.
Alberta's Mannville coals are well known for containing large amounts of water. Peter Doig of Scotia Capital wrote in a June 17, 2005 report that the buzz surrounding CBM at the recent Canadian Association of Petroleum Producers conference in Calgary has faded compared to last year, due mostly to the technical challenges posed by the Mannville coals.
On May 6, 2005 the analyst wrote that after three years of drilling uneconomic vertical wells into the Mannville coals northwest of Edmonton, Nexen [TSX:NXY] was moving to horizontal drilling in an attempt to unlock this potentially large resource play. To date, no company has announced a commercial success within the Mannville coals.
In some cases, water might have to be pumped for two to three years before CBM begins to flow. Additionally, this water can have high concentrations of salt and potentially toxic compounds. Disposal usually involves pumping the water into deep porous rock formations located far from freshwater aquifers.
One project in southeast British Columbia has been stalled by local residents, with the support of Montana politicians, due to concerns that CBM water could leak into a river that flows across the border.
In contrast to 'wet' coals, most CBM exploration and development is being carried out in the Horseshoe Canyon 'dry' coals in central Alberta that do not require dewatering.
Encana [TSX:ECA] is the largest player in the area. Production occurs by drilling a well and then injecting very high-pressure nitrogen to fracture the coal along the well bore to increase permeability. Once the nitrogen or other fracturing agent is removed, natural gas begins to seep out. As the depth increases, permeability within the coal becomes tighter, making extraction more difficult and expensive.
The Horseshoe Canyon coals have the only commercial gas to date but the production history is only three years. Effective October 1, 2004, the Alberta Energy and Utilities Board (EUB) required companies completing wells in coal formations to identify them as CBM wells and not simply as natural gas wells. This regulation was enacted to stop companies reporting CBM flow rates in the Horseshoe Canyon formation from including production from conventional sands that artificially inflated overall CBM rates.
Another factor that could hamper CBM development in western Canada is the intensive drilling required compared to the start-up of conventional gas recovery - CBM deposits may require up to eight wells per square mile versus one conventional well per square mile. CBM production also requires additional field compressors to compensate for the lack of geologic pressure.
As a result, the pursuit of CBM only makes sense with gas prices higher than $3 or $4 dollar per million British thermal units. Though prices are currently above this level, a prolonged downturn could make CBM development uneconomical.
Most of Alberta's CBM projects are in the early exploration and evaluation phases and are small parts of large companies such as Encana, Nexen and Apache [NYSE:APA]. Canadian Spirit Resources [TSX-V:SPI], a junior oil and gas player, is focused on CBM but has no production. Its shares have shed around half their value year-to-date.
Another CBM pure-play will be spun out of the planned merger between Thunder Energy [TSX:THY], Mustang Resources [TSX:MUS.A, MUS.B] and Forte Resources [TSX:FRZ]. The combination will create a CBM company along with oil and gas royalty trust and two exploration firms.
The CBM spin-off will receive all the CBM interests, including operating volumes of 2 million cubic feet per day (mmcf/d), much lower than Thunder's forecast production of between 4 mmcf/d and 5 mmcf/d by January 2005.
Management estimates that it has 150 drilling locations within the Horseshoe Canyon coals and over 450 Mannville targets over 289,000 net undeveloped acres. The Horseshoe Canyon wells should cost approximately C$50 million, while the Mannville wells could require up to C$750 million.
On May 4, 2005, Scotia Capital's Doig valued the CBM spin-off at C$0.70 per Thunder share, or 9.3% of the combined valuation, noting that the large capital commitment, the lack of production to date from existing wells and the fact the Mannville coals have yet to be proven economically leads him to remain cautious.
The promise of huge reserves and new drilling technologies designed to unlock their value hold the promise of a bright future, yet the costs, the quality of the coals, the technical challenges and environmental factors all indicate a cautious stance as the preferred outlook on western Canada's CBM potential.