January 4, 2008

China Looks to Coal Bed Methane

As the Chinese economy grows at double-digit rates, satisfying the country's energy appetite is a top priority for President Hu Jintao and his government. While China's oil companies and their search for partners in places like Sudan commands most of the attention in the West, coal is of much greater importance to China than oil.

The country relies on coal to generate roughly three-quarters of its electricity. Imports only account for 1.8% of China's coal consumption, with the rest coming from Chinese mines that employ 7 million coal miners. So it's no wonder that Beijing wants to take advantage of methane, a gas that is a byproduct of coal mining, by using it to power steel mills, heat homes, and fuel public buses and taxis.

China used 1.4 billion cubic meters of coal bed methane, or 3% of the country's total natural gas consumption, in 2006. Beijing has set an ambitious target to increase coal bed methane use to 10 billion cubic meters, or 10% of total gas use, by 2010. "I like to refer to coal bed methane as a silver bullet, so to speak, in terms of addressing both China's energy shortfall as well as China's environmental challenges," says Michael McElwrath, chief executive officer and president of Houston-based Far East Energy (FEEC), which has invested $40 million to exploit coal bed methane in China.

Methane Used to be Wasted

All that coal contributes to air pollution, some of the world's worst, in Chinese cities like Linfen, Beijing, and Shanghai. And poor safety in Chinese mines means many workers die. On Dec. 8, a coal mine explosion in northeastern Shanxi province killed at least 105 coal miners. In 2006, 4,746 Chinese coal miners died in accidents, compared to just 47 in the U.S.

Until recently, most Chinese coal mines have wasted the methane attached to the coal by releasing it directly into the atmosphere. Because methane contains 21 times more carbon than carbon dioxide, releasing that gas does much more damage to the ozone layer than burning coal. "For the coal mines in China, at the moment, safety is one of their top priorities. But you don't have to utilize the gas in order to improve safety. You can just vent it," says Henrik Dalsgard, technical and operations director at Camco International Carbon Asset Consulting [Beijing]. "Sometimes it's easier to improve something if you also make money on it at the same time."

In the past 18 months, the Chinese government has rolled out a raft of preferential policies to help the nascent coal bed methane industry achieve that goal. Coal bed methane excavation companies are being showered with tax breaks and subsidies. The government has waived import duties on coal bed methane equipment. Plus, producers are allowed to sell natural gas at market prices instead of the state setting the price. In May, China and the U.S. signed an agreement to jointly develop 15 large-scale coal bed methane projects as part of the second Strategic Economic Dialogue held in Washington, D.C.

Multinationals Taking Notice

Now, those efforts are starting to pay off. In the past year or so, foreign investment in China's coal bed methane and coal mine methane industries has skyrocketed. Multinational corporations, including such blue-chip companies as Caterpillar (CAT), General Electric (GE), and Chevron (CVX), have invested $25.4 billion into the sector to date, nearly half of that in 2007, according to China United Coal-Bed Methane [CUCBM], the state-owned enterprise with which all foreign investors have been forced to partner. In the past 15 months, Caterpillar has sold more than 100 gas-powered engines manufactured in Lafayette, Ind., to coal mine methane-generated power stations in China despite local competition making smaller, less technologically advanced engines that require more frequent repairs. "The Chinese-made engines have a long way to go," says Thomas Teo, general manager of Caterpillar's greater China region electric power division.

Moreover, the Kyoto Protocol has created financial incentives for power plants to switch to methane from coal. Chinese power plants using methane captured from coal are eligible for carbon credits under the Clean Development Mechanism [CDM] -- an arrangement under the Kyoto Protocol allowing developed countries to lower their carbon emissions by buying carbon credits from renewable energy projects in developing countries.

Stymied by Lack of Infrastructure

The carbon credits can make the difference in profitability of a project. Investors in the largest coal mine methane project in the world in Jincheng, Shanxi province, found that without the carbon credits, the 120-megawatt plant would not be viable. "Without CDM, most of these projects would be marginal. CDM is creating that extra financial incentive," says Andrew Aldridge, vice-president, China, at Climate Change Capital, a London investment bank specializing in carbon trading.

The sudden demand for methane has caught coal mine methane excavation firms by surprise. One of the first foreign companies to begin extracting methane from coal bed methane in China, Beijing-based Asian American Gas, expects to produce 700 million cubic meters of methane from its coal bed methane site in Panzhuang, Shanxi province. However, the market demand from nearby steel mills and glass factories is 1.8 billion cubic meters, or two-and-a-half times Asian American Gas' full production capacity. "Only by producing gas in huge amounts can you gain the market. Otherwise, the market just ignores you," says Steve Zou, CEO and founder of Asian American Gas,

Perhaps the biggest bottleneck for China's coal bed methane industry is the lack of a natural gas pipeline infrastructure. Without pipelines in place, many investors are unwilling to invest too much money into natural gas exploration. Now, as companies are starting to extract methane from virgin coal beds and coal mines, the government and private investors are rapidly building a web of pipelines connecting natural gas fields in Central and Western China to cities along the coast. The government is planning to spend $375 million between now and 2010 to build two main pipelines for coal bed gas transmissions. Companies -- including CUCBM, Sinopec (SHI), and Asian American Gas -- are also planning to build the pipelines.

Public Transport Making the Switch

In the meantime, coal bed methane companies are compressing or liquefying their methane and shipping it as liquefied natural gas or compressed natural gas to customers. Green Dragon Gas (GDG.L) has invested more than $75 million into five coal bed methane projects in China. The London-listed firm has started to extract methane out of its concession in Qinyuanan, Shanxi province, and uses some of it to run gas-powered generators at the site. The surplus methane is compressed and trucked to gas stations in Zhengzhou, capital of the neighboring Henan province. "By far the majority of the taxis and public transport in Zhengzhou is already switching to gas. I think that you'll see that trend in inner-China cities quite extensively as the oil prices continue to go up," says Randeep Grewal, CEO of Green Dragon Gas.