Green Dragon Gas:

JRS CORPORATE
Leading the Chinese green
VOLUMEFIVEISSUETHREE
September 2009
WWW. CORP-INTL .COM
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CORPORATE INTL
Green Dragon Gas:
energy revolution
Green Energy
Green Dragon Gas:
China’s green energy leader
The recent joint venture between US integrated energy company ConocoPhillips and
Chinese vertically integrated gas business Green Dragon Gas is the culmination of
more than10 years of work to bring sustainable flows of natural gas to the Chinese
market in line with the Chinese Government’s clean energy objectives and needs.
“Greka China secured the first
of its six Production Sharing
Contracts (PSCs) with the Chinese
Government in 1998 and signed
four more in 2003. It then
acquired one more through the
acquisition of Pacific Asia China
Energy (PACE) in July 2008.
Green Dragon Gas is an AIM listed Chinese coal bed methane (CBM)
business that is aiming to become the largest vertically integrated supplier
in China, providing compressed natural gas (CNG) to wholesalers, power
companies and CNG retail stations. Importantly, unlike natural gas, CBM
is priced at market prices in China, reflecting Chinese policy on developing
this green energy resource.
Green Dragon Gas is the parent company of Greka China, which is exclusively focused on the gas industry in China. Greka’s business plan is to
generate its CBM supply from six production sharing contracts located in
Shanxi, Jiangxi, Anhui and Guizhou province covering acreage holdings
of a total of 7,566 sq km.
Greka China secured the first of its six Production Sharing Contracts
(PSCs) with the Chinese Government in 1998 and signed four more in
2003. It then acquired one more through the acquisition of Pacific Asia
China Energy (PACE) in July 2008.
This array of PSCs has given the company drilling rights across six CBM
blocks and access to gross gas-in-place (GIP) of 25.5 trillion cubic feet (TCF).
A series of acquisitions since the company listed on AIM in August
2006 have provided tangible accretive value for shareholders and given
Green Dragon Gas control of additional upstream assets in addition to
midstream, downstream assets and technologies that add dramatically to
the upstream resource.
Accretive acquisition trail
In November 2006 Green Dragon Gas acquired a 49% stake in Kesi
Hengrun (Beijing) Technology Co Ltd, which gave it a 29% stake in
Beijing Huayou, a downstream gas distributor in southeastern Beijing
serving almost 20,000 households and some large industrial customers.
In June 2008 the company acquired Giant Power International, providing two strategically located gas distribution centers off the West-East
CNPC pipeline in Henan and Anhui province.
Perhaps the most significant acquisition to date is that of PACE in July
2008, which gave the company a sixth CBM block and a 50% joint venture
10 Corporate INTL September 2009
with Mitchell Drilling and access to its revolutionary Dymaxion surface-to-inseam horizontal drilling technology.
Stephen Hill, Vice President of Corporate Communications at Green Dragon Gas, is upbeat about the progress
of Green Dragon Gas and says every acquisition made by
the company has been very shareholder accretive.
He said: “The last three years, prior to the most
recently announced ConocoPhillips Joint Venture,
there have seen a series of acquisitions both on the
technology side of our business with the aim of
controlling costs of production as well as acquisitions
aimed at securing strategic customers. The technology
we have acquired ranges from seven Schramm drilling
rigs, in house drilling teams, to the joint venture with
Mitchell Drilling of Australia. The other acquisitions are
based on getting customers, whether that’s the Beijing
pipeline (Beijing Huayou) or mother stations off the west
east pipeline where we take gas and sell that to a myriad
of customers.”
He added: “That’s the backdrop of the last three
years and it has allowed us to fold in the ConocoPhillips Joint Venture on the upstream end of the business,
such that we have our costs under control on the one
end and our customers and pricing on the other.”
The most recent independent resource report from
Netherland Sewell & Associates shows that the proven
and probable (2P) reserves of Green Dragon Gas
amount to 258 billion cubic feet (BCF) with present value of future net revenues (PV10) amounting
to $US1.1 billion. The proven, probable and possible
(3P) reserves are estimated at 2,161 BCF, net to Green
Dragon Gas, with a PV10 value of $US7.2 billion. These
figures make very positive reading when set against the
current market capitalization of Green Dragon Gas at
$US716 million.
Mr Hill says that the 3P PV10 figures have increased
significantly on previous reports largely because of the
successful drilling results and technology application
enhancements provided by the acquisitions.
He said: “We had a very large bump on our upstream
resource from the 2007 yearend Netherland Sewell
report, which came out at $US5.5 billion, to the 2008
yearend saying $US7.2 billion, based on the future revenue from gas net to Green Dragon Gas. That valuation
bump largely came from our advanced horizontal drilling
technology application versus the traditional vertical
drilled wells, which added more than $1billion from an
acquisition (PACE) that cost us less than $US37 million.”
He added: “Once the stock market appreciates the
value of the acquisitions we have made and understands
the value of the ConocoPhillips JV to the overall business it would be reasonable to expect a significant re rat-
ing of the Company.What we have been doing is building a business around the
resource. We are already in commercial production of gas in one of our blocks
with an additional five large projects to come on stream in the years to come.
This is a very good strategy and I do believe that the market is not fully aware of
the value of the purchases that we have made, both in terms of cost savings and
revenue collection.”
An historic joint venture
The joint venture with ConocoPhillips was announced following seven
months of due diligence by the major energy company, which is also one the
world’s largest CBM producers. Acknowledging Greka’s operating expertise,
ConocoPhillips accepted Greka as the operator of the project. Additionally,
ConocoPhillips will pump an initial irredeemable $50 million into the project
(in two stages) before getting any access to revenues. Following this ConocoPhillips then has an option to pay a further $120 million towards a joint
venture giving it access to 50% of the revenues from three of the six CBM
blocks being drilled by Green Dragon Gas.
Mr Hill says this makes a big statement about the confidence ConocoPhillips
has in Green Dragon Gas and its potential scale of the revenue streams as a
super major energy company must have scale of operations for it to participate.
He said: “As a big international ConocoPhillips has been in China for more
than 20 years and this is their first onshore business venture. That is a very
big statement from them. The first part of the deal ($50 million cash injection) is 100% carry to Green Dragon Gas, there is no share holder dilution,
debt or lien on the company with no recourse or, to put it simply, an option
price to pay for a participation.”
He added: “The general perception from investors is that this is a 50/50
joint venture where ConocoPhillips spends US$170 million on three PSCs.
That is the perception, but not the reality. The reality is that we get additionally that US$170 million back in cash flows to Green Dragon Gas before
ConocoPhillips receives a penny.”
Mr Hill says that ConocoPhillips expects the project with Green Dragon
Gas to be a multi TCF (trillion cubic feet) joint venture net to them.
He said: “It’s a big commitment for them and a vast deal for us. If you
compare the multi TCF statement to our reserve reports, it becomes clear that
they see a significant upside that hasn’t yet been talked about in our current
reserve reports from Netherland Sewell. Our current 3P reserves are currently
estimated at 2.2 TCF. At the moment (after paying $170 million) they would
enjoy revenues from 50% of that 2.2 TCF only after the cost recovery to us.
That’s not a multi-TCF figure net to them, so they must be looking at a much
bigger story than the current reserve reports show. That’s a big underline for
Green Dragon Gas shareholders.”
The horizontal drilling technology from Mitchell Drilling is another big
factor in the joint venture with ConocoPhillips and has been a catalyst in
increasing PV10 figures for several Australian gas companies.
The technology was partly responsible for boosting 3P PV10 numbers for
numerous Australian Energy Companies prior to the arrival of the majors in
Australia on their recent spate of acquisitions there. The focus was 3P valuations
and that was the eventual prices paid averaging US$21 per BOE compared to
Green Dragons current value at US1.98 per BOE.
The joint venture also gives ConocoPhillips an option to buy into the mid and
downstream businesses of Green Dragon Gas, including its CNG distribution
September 2009 Corporate INTL 11
Green Energy
“Green Dragon Gas has made a
commitment to moving to the main
board of the Hong Kong Stock
Exchange by the second quarter
of next year, but that may change
depending on ongoing discussions
with shareholders and brokers.”
stations and the gas distributor Beijing Huayou.
Mr Hill said: “They have a right to talk to
us about our mid and downstream businesses
though the price of any desired participation
is yet to be discussed. They have Australian
gas coming on stream in 2014 a lot of which is
bound for China. This gives Green Dragon Gas
shareholders a big option on what could happen
in the future.”
Prospects for natural gas in China
The future for Green Dragon Gas looks bright as
the Chinese Government continues to support
the increased use of natural gas in the economy.
A study by the China United Coalbed Methane
Co (CUCBM) has predicted that annual gas demand is expected to reach 210-250 billion cubic
metres (BCM) by 2020, versus production of 76
BCM in 2008. Natural gas currently comprises
22% of the world’s energy consumption, but
only 3% of China’s, and it wants to increase that
figure to 5.3% by 2010, amounting to natural gas
consumption of 20 BCM.
Coal bed methane (CBM) production is set
to increase to 10 BCM by 2010, from a figure
of 1.3BCM in 2006. Figures from Westhall Research show that CBM production could rise as
high as 78 BCM or 49% of domestic gas production by 2020.
Mr Hill says that Green Dragon’s vertically
integrated structure is ideally suited to deliver
on the expanding demand for natural gas and is
putting in place the infrastructure to sell directly
into downstream markets.
He said: “The original PSCs were given to five
companies at a time when China needed foreign
money and expertise. The conditions in China
today are very different to that period, and that’s
a unique plus for Green Dragon Gas. China has
designated CBM as one of their key policies for
clean energy, and there are huge incentives for
the company involved, whether they are tax or
capex related. In Beijing many of the buses run
on compressed natural gas (CNG), in Zhengzhou
70% of all buses and 60% of all taxis run on
CNG. There are also incentives for vehicles to be
converted to CNG. It is 40% cheaper with 90%
less in emissions to run a car on CNG vs petrol
or diesel in China. dditionally Chinese power
companies are being given incentives for CBM
power plants, the first CBM driven power plant
was given Government approval recently.”
Green Dragon Gas is actively developing its
12 Corporate INTL September 2009
customer chain and has two part-owned CNG
distribution stations in Wuhu and Zhengzhou
connected to the West-East pipeline and capable
of supplying downstream markets.
Its investment in Beijing Huayou has given the
company access to households and businesses in
the Beijing Development Area, with key customers including Mercedes Benz, plus a gas fired
power plant and a water heating company.
Green Dragon Gas also owns four CNG stations with approved licences in Henan province.
The future for Green Dragon Gas
Green Dragon Gas is working towards further
organic growth, sustained well drilling and the
delivery of more gas to the Chinese market.
Despite a focus on organic growth, the
company will still consider acquisitions that can
demonstrate shareholder accretion within its
strategic inner China niche.
Mr Hill said: “We will definitely focus on
drilling wells, but I don’t think people should
just assume it’s 100% about drilling wells, if we
see something that makes sense we won’t steer
away from an acquisition opportunity as we have
demonstrated over the last three years. We are
always on the look out for things that add value to
Green Dragon Gas – it’s a very good playing field
that we sit on in China.”
Green Dragon Gas has made a commitment
to moving to the main board of the Hong Kong
Stock Exchange by the second quarter of next
year, but that may change depending on ongoing
discussions with shareholders and brokers.
Mr Hill said: “We have been listed now on
AIM for three years and we have recently been
thinking about moving to the main board in
London. That continues as a possible avenue that
we believe we qualify for.”
He added: “AIM has been good for the
company, I can testify to the fact that in Asia the
majority of people didn’t understand CBM three
years ago, but in London there was a much wider
and experienced client base. Today we are the
largest Chinese company on AIM and, although
we have an 18% free float, investors buy the stock
and sit on it due to the obvious value, limiting the
trading daily trading volume in the stock – that’s
something that we need to address. The majority
of our shareholders are very large institutions that
we have placed stock with around the time of our
acquisitions, but they are putting those shares
away, rather than trading them.”