Deep pockets needed for methane

07/05/2008 - 22:00

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From uncertain beginnings in the early 1990s, Australia’s coal seam, or coal bed, gas (CSG) or coal seam methane (CSM) business has come a long way. Today, we see a large cohort of companies involved in the local industry, supplying more than 70 per cent

Deep pockets needed for methane

From uncertain beginnings in the early 1990s, Australia’s coal seam, or coal bed, gas (CSG) or coal seam methane (CSM) business has come a long way. Today, we see a large cohort of companies involved in the local industry, supplying more than 70 per cent of all the natural gas used in Queensland.

Briefcase estimates that Australia’s CSM production has risen to around 110 petajoules per annum, or around 300 million cubic feet per day, and government studies indicate that Australia has the potential for 350 trillion cubic feet of recoverable CSM.

By comparison, production of CSM in the US from the Powder River Basin and other areas has risen to 1,800 billion cubic feet a year, or about 5,000 million cubic feet per day, supplying around 7.5 per cent of total US gas demand. Since no company is really making a positive free cashflow from the business, valuations in the industry are driven by corporate position taking, with recent transactions valuing proven and probable gas reserves at around $1.50 per thousand cubic feet (Mcf).

Let’s step back and try to understand just what CSM is all about. Conventional natural gas is formed when sediments containing marine or terrestrial organic material such as plant or animal waste are deeply buried and cooked up at elevated temperatures in an anaerobic environment over millions of years. Mixtures of methane, ethane and propane gases are produced, along with larger chain hydrocarbons, which occur as crude oil. These hydrocarbons then migrate through porous and permeable sediments until they are trapped in a reservoir.

In the case of CSM, methane is produced as a by-product of the coalification of thick, organic deposits. Coal is formed when rich deposits of vegetation are buried and slowly cooked in the absence of oxygen. Water is first squeezed out and then the plant matter is transformed into coal of varying ranks. Peat is an early stage of this process and lignite, or brown coal, is the lowest rank of coal.

Not all coals contain usable methane. Low-ranked coal, such as the brown coal found in Victoria’s Gippsland Valley, do not contain usable methane, but thermal and higher ranked Jurassic coals found in the Surat, Clarence Morton and Bowen basins of Queensland and New South Wales have some of the world’s best potential for extraction of CSM.

Unlike conventional gas deposits, methane associated with coal is not immediately free to flow into a well drilled into the coal. Each molecule of methane is physically absorbed onto the surface of the coal and will not flow freely from the coal until the pressure within the coal seam is reduced.

The other major difference between coal gas and conventional reservoirs is that coal has very low porosity and permeability. Conventional reservoirs can support gas flow of many tens of millions of cubic feet (mmcuft) per day from each well, whereas flow rates from CSM developments in the US are typically 100 to 500 Mcf per day, or less than half a mmcuft per day from each well. In the case of CSG, once desorbed from the coal, gas molecules must make their way along cleats and fractures which occur naturally within most coal of an appropriate rank, so as to reach the recovery point.

As with conventional gas, CSG is not always pure methane. CSG may hold high levels of carbon dioxide or other unwanted gases, but CSG will only contain methane and no larger carbon chain gases or liquids, which might otherwise enhance its value.

Exploration for CSM involves drilling core holes to measure coal seam thickness while recovering core samples, which are stored for later laboratory examination to determine how much methane is trapped in each cubic metre of coal.

Early attempts to develop CSM in Australia applied conventional drilling and well-casing technology. The idea was to enhance permeability by fracturing the coal though cased holes and pumping water out of the wells until gas began to flow. This technique did not work, as it damaged natural fractures in the coal and stopped methane flowing. More recent drilling techniques involve low-cost drilling with converted mineral rigs, followed by internal reaming of the hole over the coal zones to remove any damage caused by drilling. The wells are then cased with pre-slotted steel of PVC liners and water is pumped from the wells to reduce the watertable and depressurise the coal formation.

Typically, a pilot is set up with four wells on the corners of a 400-metre square and a fifth well in the centre. The performance of the central well, which has the benefit of the dewatering effects of the surrounding wells, gives good data on the ultimate performance of the particular coal seam and allows the booking of a proven and probable gas reserve estimate. Physical performance depends on the gas content of the coal, the depth of burial and the amount of natural fracturing, which enhances gas permeability.

In the US, CSM is sought at depths of more than 1,000 metres. Deep coals will have higher formation pressures, but natural fractures will be restricted by that high pressure, while coal at depths shallower than 200 metres is unlikely to have sufficient formation pressure to achieve meaningful gas flows.

In the Bowen Basin, Queensland Gas has achieved astounding results, with individual wells flowing at more than 3 mmcuft of gas per day and large fields averaging over 1 mmcuft per day per well. This is a remarkable performance compared with producers in the US, who are delighted if they can achieve 0.3 mmcuft per day from each well.

While the leaders in this industry, including Santos, Origin, Queensland Gas, and Arrow Energy may be generating small operating cashflow surpluses from their CSM businesses, they are still very much negative on a free cashflow basis.

For instance, in the half-year to December, Queensland Gas produced an operating cash flow of $5.1 million, but spent $70.1 million on project developments. In an attempt to boost its revenue, Arrow Energy has diversified into power generation. Its recent half-year result reveals an operating cash flow of just $2 million and spending of over $40 million on projects, or spending of $236 million if acquisitions and investments are included. The situation is little better in the March quarter with Arrow reporting an operating cash flow of $20 million, matched by spending of $74 million, $40 million of which was a loan to its power plant partnership. Clearly these companies are spending like it is going out of style.

Ultimately, commercial success for CSM projects depends on a matrix of factors including the gas sales price, gas content of the coal, and cost of each well, time to first gas flow, ultimate gas flow rates, gas quality and the ultimate gas volume recoverable from each well.

If each well costs, say $450,000 to drill and complete for production, at a gas price of $A3 per thousand cubic feet (Mcf), this well might take two years to pay back its initial cost as the gas flow rate ramps up from zero to, say 1 million cubic feet per day, and its ultimate real return on capital may not be so flash.

The CSM business thus requires deep pockets and patient capital. Having established ample reserves and high deliverability in Queensland coals, the key impediment to success remains a low gas price of around $A3/Mcf. While there are already efforts to boost revenue by going downstream into power generation, existing players are also banking on development of an LNG export industry to deliver a global price for their gas which, after the cost of capital, plus transport and conversion, might effectively be closer to $A7/Mcf at today’s market.

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• Peter Strachan is the author of subscription-based analyst brief StockAnalysis, further information can be found at Stockanalysis.com.au

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