LONDON () -- The advantages of natural gas are well known and documented. It is the cleanest and most efficient fossil fuel, suitable for a wide range of residential, commercial, industrial and transport uses. Gas fired power stations are relatively inexpensive and environmentally friendly. Gas demand has grown faster than oil and coal over the last 40 years and the US Department of Energy estimates that global gas demand will double over the next 20 years or so compared with a 20% growth in oil demand over the period.
Coal bed methane (CBM) is just natural gas derived from coal seams. It is formed from the decay of organic matter in sedimentary rocks during the coal forming process and has identical properties to conventional natural gas and so can be used in the same way.
Typically it has a number of advantages over conventionally sourced natural gas as:
- It often has a higher gas content than a conventional gas reservoir.
- It is generally closer to the surface and so there are lower drilling and maintenance costs per well.
- It is easier to find as CBM is known to occur in coal deposits. Moreover coal seams are typically extensive.
- It is often in a convenient location relative to major markets because of its association with coal. This is a major plus point in an industry in which frontier reserves in places such as the Arctic and deep water account for more than half of the world's proven reserves.
A company that is poised to take full advantage of CBM fundamentals and which currently appears under-valued relative to its peers is European Gas Limited [ASX:EPG]. CEO Anthony McClure presented the case at the recent Mining Journal Energy conference in London.
European Gas Limited began life in 1998 as Kimberley Oil NL [ASX:KBO], a conventional oil and gas company holding 30,000 square kilometres of hydrocarbon exploration permits and production licences in the Canning Basin of Western Australia.
In the last few years, at the instigation of the shareholders who wanted the company to seek new business opportunities, it has undergone radical change; not just of name but also of status, management, technology and continent.
Now the company's main aim, as the new name implies, is to acquire, evaluate and develop gas projects in Europe, specifically Coal Bed Methane (CBM) and Coal Mine Methane (CMM) projects in France and Italy. The first European permits were acquired in November 2004 and to date it has a portfolio of seven projects.
Currently the most important and most developed of the projects is the Lorraine basin in France, a historic coal mining region close to the German border (though all the coal mines have now closed). The project was originally owned by Enron who determined that there were 6.9 trillion cubic feet of coal bed methane in an area of 680 square kilometres. (this being enough to meet the needs of 6.9 million households for 15 years according to the American Gas Association!). Enron's lease lapsed when the company got into difficulties and the entire permit area was acquired from the French government in 2004 by a JV between EPG (with a 75% share) and Heritage Petroleum.
EPG has since conducted a major review of the CBM potential of the project aided by an extensive mining, seismic and drilling database (on 600 drill holes) from Charbonnages de France. It has determined that there is a gas in place resource of almost a trillion cubic feet (991.2 billion cubic feet or 28.1 billion cubic metres) in an area of just 68 square kilometres - though this is just a small fraction (7%) of the total permit and application area.
It is now beginning a two well pilot program drilling to 1200 metres each with two 500 metre lateral wells. Pilot production will begin in the second half of this year with a view to rolling out to a 30 well production next year. It is hoped that full production can start in 2008 though this will depend on access to the pipeline which in turn will depend on the environmental reports. Production in 2007 will be commercialised either by producing electricity or ethanol.
EPG's other projects include two further permits in France (Gardenne in the South East and St Etienne in the East) and two in Italy (Sulcis in Sardinia and Tuscany). It has also applied for two further permits in France (Lorraine Sud and Lons Le Saunier). Together the projects have a total area of 8,189 square kilometres. It has just completed the sale of its Australian assets to Arc Energy Limited [OTCPK:ARQFF] in order to focus on Europe, although it will maintain a significant leverage in any future discoveries in the region.
The Investment Case
Here are ten good reasons for investing in EGL, though of course the risks listed in the conclusion must be borne in mind!
- EGL's projects are based in the heart of Europe: They are close to large industrial populations and thereby a large market. The workforce is well trained. Europe is financially stable with a first world regulatory framework.
- Gas is a popular and well established fuel in Europe with an extensive pipeline infrastructure. Demand is set to increase. Gas currently accounts for 25% of primary energy demand, but the gap between production and demand is widening. The current energy mix is unsustainable in view of the high cost of local production of both coal and oil and the depletion of North Sea reserves. Gas is likely to gain market share in the future; more than half of all new power generation capacity in Europe will be gas fired. European gas markets are free and open and there is an extensive pipeline infrastructure with pipelines already in all of EPG's permit areas.
- Security of energy supply is a major strategic issue in Europe. This creates good opportunities for European companies to enter the market and produce locally. There are concerns about the over-dependence on Russia which now supplies 20% of French gas demand, 25% in Italy and 30% in Germany. There was a wake-up call earlier this year following the 'spat' between Russia and Ukraine. (Ukraine declined to pay the 400% price increase demanded by Russia's Gazprom to put prices in line with exports to other countries. Gazprom promptly cut supplies to Ukraine, at which point there was a temporary restriction of supply to Western Europe from the pipeline which transits Ukraine. Gaz de France, for example, announced that supplies were down 25-30%.). Gas storage levels are poor in Europe so continuity of supply is particularly important.
- Gas prices are typically strong in Europe because of supply and storage issues. For the last year gas prices in Europe have been three to five times what they are in Australia, buoyed by the protracted winter and the Russian disruptions. They are likely to remain high driven by increasing demand and high prices for alternative fuels.
- The French government has been extremely supportive of the project. There is a strong desire to see the project succeed and recognition of its strategic importance. EPG has been given full access to all the data available for the Lorraine basin. The company will further explore the various government and financial support incentives available for depressed high unemployment regions (unemployment in Lorraine is close to 20%).
- EPG is an early entrant into CBM in the French market and so has been able to secure a large acreage. Although Coal Bed Methane extraction is in its infancy in Europe it has been commercially produced in the US for more than 20 years where production, at 1.7 trillion cubic feet per year now accounts for 10% of the total. It has also been produced for several years in Australia. As technology has improved so more difficult coals can now be exploited. The Lorraine project is very large by worldwide CBM standards.
- For the most part the geology of the Lorraine project is favourable. The gas is good quality. EPG will overcome the low permeability of the Lorraine project by the use of lateral completion wells. The coal seams have a high gas content and good thickness. The gas is 96-98% pure methane and will need only to be dried and compressed before being injected into pipeline. There are low volumes of carbon dioxide. The main issue is the low to moderate permeability (degree of fracturing in the coal) which EPG will overcome through the use of lateral wells (which are dendritic with horizontal branches). The technology is well established in the US and Australia; drilling is very accurate (to within 10cm in a horizontal distance of 1km) Lateral completion wells allow for a higher production rate and a more rapid dewatering period.
- The project will be environmentally friendly. Lateral wells are environmentally friendly as only one well is required per 2 square kilometres (compared with 6 vertical wells in an equivalent area). The surface footprint is therefore small. The wells are discreet, housed in a shed with an access road. The pipeline infrastructure is all below the surface.
- There may be an opportunity to commercialise water. Water disposal is an issue with all coal bed methane projects - it can account for up to 50% of total operating costs. In this instance there is not a huge amount of water as the coal in Lorraine is not completely saturated. Moreover the water is relatively clean. The company is therefore exploring all avenues. In the best scenario the water might be commercialised and sold, either for farming or for drinking. In the worst case scenario it would be re-injected.
- For the moment the share price looks cheap. With just over 160 million shares in issue and a share price of around A$0.38 the market capitalisation is just over A$61 million ($45 million). The price is well down from its peak of A$0.75 in March and the price is falling, but is more than three times its level at the beginning of the year (A$0.12). EPG are planning to list on AIM by the end of the year.
An analysis by Martin Place Securities in February concluded that the market had yet to recognise the full potential of EPG. At the time shares of the EPG's peer group in Australia were trading at an average of around 77 cents per thousand cubic feet of reserves where EPG were very significantly below this and even with conservative assumptions about recovery rates the stock could be re-rated over the next 12 months.
Of course there are risks. The company, in its new form, is young. It has yet to pilot production. Martin Place Securities identify the major risks to project success as exploration, water disposal and commercial development arguing that while EPG's gas-in-place estimates are very robust it has still to determine the percentage of the resource that can be commercially recovered.
But there is significant upside potential with EPG well positioned to benefit from the strong fundamentals in the gas market. It will be using proven and environmentally friendly technology to develop an extensive, good quality resource where it will be on top of an existing distribution infrastructure, close to major markets, the supply will be of strategic importance and it has the active support of the government.
Altogether a compelling case to track the shares and watch for a turning point.