Description

Valuation should increase from 29 cents/mcf recoverable toward world levels of over $1.00/mcf afforded substantial producing CBM players in areas of high netbacks.  In 2008, this Indian Coal Bed Methane producer will post its first year of substantial gas production & cash flow.  GEEC could triple+ in the next few years and still be valued below international comps.

GEEC is a low-risk growth E&P with these attributes:

1)  A play on the development of Indian infrastructure, economic growth, and the dire shortage of natural gas on the subcontinent

2)  Fully funded development program which can extract 1.1 TCF with no need for any equity dilution

3)  Production just began and will grow 10mmcf/d per year or more for several years as they transition into a major producer

4) Currently valued at 29 cents per recoverable mcf which is about the cheapest in the world for a producing CBM site with known reserves

History

GEEC was started by YK Modi in 1992.  The Modis are a Rockefeller-type, politically connected Indian family that has been controversial in the past.   In the 1970s their Modi-Xerox JV ran into partner disputes with lawsuits flying.   Various brothers/cousins control Modicare (a direct selling biz),  Modi Healthcare Placement (Nurse recruiting), Godfrey Phillips (tobacco),  Modi Threads (polyester & cotton),  Modi Rubber, there’s a chemical company, an airline, …and the list goes on…etc.   YK Modi’s end of the family owned tea fields, which he sold to Unilever in the 1990s.  He subsequently funded other businesses including a pager network, a tradeshow exhibitions company, and was President of the Federation of Indian Chambers of Commerce.  But GEEC is now his fulltime gig and is by far his most sizable asset with 64% of the stock under his control.  When asked recently what it would take for him to sell the company, he stated that he would sell the business for $1.5B (which is 1.30 per mcf and a good approximation of current fair value that is in line with international comps)… I think he’ll get it within three to five years.

Y.K. Modi acted as an advisor to the Indian government in the original auctioning of coal bed methane gas properties around India.  For his help, he was offered the first choice of the properties which allowed him to select the area with best permeability, best saturation of gas per ton, closest to infrastructure, etc.

Gas Market in India

Industrial users suffer daily rolling blackout periods and pay $7-8 per mcf when they can get supply.   Many small business users can’t get supply because their use is too small to justify pipeline extensions and instead use Naphtha (compressed and trucked-in) at end user rates of over $18/mcf and up.   Though a huge amount of new supply will hit the Indian market in Q3 2008 as the offshore block known as D6 (owned by Reliance & Niko) comes online, that gas will be pipelined to Mumbai situated on India’s west coast.  GEEC serves an industrial area 100 km NW of Calcutta which is in the east and will not have access to any of this new supply.   There have been discussions of other potential supply sources including a pipeline from Myanmar that would be many years off, and it is currently stalled in the concept stage due to opposition from China and other political reasons. 

Currently, the company is selling its small amount of gas production to small local industrial users (a biscuit bakery, other food producers, a glass mfg company) at prices of $16-18 per mcf with netbacks over $9/mcf after compression and trucking costs.  These customers pay on delivery and are thrilled to get lower prices and consistent delivery given their previous use of Naphtha.  However, there is a finite amount of these smaller industrial users.  The majority of GEEC’s offtake will be sold via pipelines to large industrial users (steel, ceramics, chemicals) where current market is $7-8/mcf with netbacks of $6-7.  GEEC’s gathering station for industrial sales should be completed in January and there will be a build-out of pipelines as production grows to a point where they can contract for delivery.  In addition, there is a limited amount of retail gas station offtake for cars using CNG (mandated for taxis and buses) that could have high netback realizations.  GEEC has a JV agreement with Indian Oil Corporation (IOCL IN) for six initial compressed natural gas outlets for consumer sales at $15.17/mcf inside IOCL’s retail gas stations, netbacks of $9.  Eventually the company envisions selling 25% to small users ($9 netbacks), another 25% to automobiles in the JV with IOCL ($9 netbacks), and 50% to large industrial users ($6 netbacks).  This implies a $7.50/mcf average netback based on current market prices.

Gas in place

Reserve auditor Netherland, Sewell & Assoc (NSAI) gave them 1.92 TCF of original gas-in-place in their June 2007 report.  This was an increase based on recent wells drilled and exceeded the amount in a report from Slumberger done in fall 2005 that suggested a 60% recovery rate.  At 60%, there is 1.152 TCF of recoverable gas, which I feel is conservative.  CBM experts at Weatherford’s Energy Ventures (WFT’s private equity subsidiary) believe the ultimate recovery rate will be 80-85%, and attempted to buy into the company pre-ipo because they feel their horizontal drilling techniques could add value toward this increased recovery (not to mention bring WFT a pile of drilling contracting biz).  Negotiations got as far as an MOU, but they didn’t complete the deal.  However, GEEC ended up contracting WFT’s services anyway, thus far for vertical drilling & fracs.

Because their 210 sq km block has had extensive appraisal drilling done by government coal companies (308 wells over 40 years) in addition to their own drilling, there is a great knowledge base that fully identifies the layout and depths of the coal seams which are saturated with the gas.   Although valued like a prospector, this is a development story of a known resource.  Though the 1.92 TCF in place is technically a “P3” number, the company, its technical advisors, its bank lenders, its contractors, and this investor all believe that most of this resource will be converted to P1 by 2009 as more producing wells allow the auditors to re-categorize.   There is no exploration risk to this gas in place, which is a feature common to coal bed methane deposits in known coal seams worldwide…. Quite a contrast to P3 figures for traditional exploration companies.

Drilling Program & costs

The current drill program targets clusters of 20 wells, with each set costing $22m including fracs, tie-ins & gas plant facilities.  So the cost is approx $1.1m per well.  It takes approx 10 days to drill a well including moving the rig to the next pad, and they bring out the frac truck which comes at a $10k dayrate once there are enough wells to keep it busy for a while.  Lifting costs will be extremely low once wells are in production and should be under $1.00/mcf which is mostly a 12% government royalty. 

Any CBM development starts with a trial and error process to determine how best to frac the wells to achieve productive flow rates, and to learn which equipment works best for their particular geology.  GEEC has already climbed that learning curve and figured out (the hard way) that it needs to frac with a mix of 5% resin in the sand and must use a special grade of cement and a particular type of filter so that particles down the well don’t clog up their pumps.   Expensively, it learned this over the past year and a half as it drilled 23 wells and fraced 22 of them on two seams and the one on all ten seams.   Going forward they will target 30 to 40 new wells per year and all wells will receive fracs that will cover all ten seams, and be replicas of the last few wells which are producing above plan for the 300/day/well model.  The company expects corporate overhead to be $2m/year which allows them a platform that can handle their future production level.   Well productivity and much else about the company can be seen on their Investor Presentation and website at www.geecl.com. 

Production & Cash flow

The cash flow per set of 20 wells should be $13m at final sustainable flow rates for each well of 300 mcf/day and netbacks of $6 per MCF (20*300*6*365).  The key with the flow rates is that it takes up to 9 months of dewatering for the wells to start producing significant gas, so cash-on-cash payback times can be up to 3 years.  However, the wells have enormously long lives, and after dewatering, will actually have a 3 to 5 year spike in gas output above 300 MCF per day.

From a standing start in July, production hit 1.5mmcf/d (million cubic feet per day) in September and in November was over 2.5mmcf/d with over 5700 bls of water also being produced.  They expect an exit rate for 2008 of over 10mmcf/d which implies $20m of exit rate ebitda at $6 netbacks.  2009 will add at least another 10mmcf/d to reach an exit rate over 20mmcf/d implying over $40m in ebitda.  By that time they’ll have approx 80 wells in some stage of production or dewatering and will be able to see production grow as the gas/water ratio improves.  There are 300 drilling locations on the current land area so ultimately they’ll have production of approximately 90mmcf/d (300 wells x 300mcf/well)…   Put a $5 (or $6) netback on those ultimate production rates and it cash flows $164m/yr someday five or six years hence (90,000 x $5 x 365 days)…  all with no equity dilution which is a key to this story.

All figures in USD                                                 

Exit 08             Exit 09             Ultimately

# of mature (dewatered) wells               33                    66                    300

Production in mcf                                  10,000/day       20,000/day       90,000/day

EBITDA @ $5.00 netback                   $16m               $34m               $164m

EBITDA @ $6.00 netback                   $20m               $41m               $197m

EBITDA @ $7.50 netback                   $25m               $53m               $244m

(assumes $2m corp. overhead, & zero for carbon credits)

Valuation

After a private funding round of $6.5M in April 2005, GEEC LN went public at 101p in Dec 2005.  Arden Partners was the lead manager. Jeffries was brought on as co-Broker in the past month to add liquidity and a greater number of holders.  The cap structure includes:

109m shares out at 162p (GBP/USD 1.995)

$352m market cap

  $15m in cash

No debt ($88m untapped credit facility in place)

$337m EV or 29 cents/mcf  recoverable  ($337/1152)

The $15m in cash will be spent, and in early 2008 they will begin to tap their credit facility which was provided by an eight bank consortium led by State Bank of India at 13% (prevailing rate in India).   They will be able to renegotiate the rate on the credit facility to ~8% upon gas sales under contract to larger industrial customers.  To do this, production would need to be higher so it is probably a 2009 event.

The company expects to draw approximately $4m per month for drilling with stops in the rainy seasons.   Current plans are to draw $40m in 2008 and the balance in 2009.  But that will be it at $88m in total debt…. By that time (end of 2009) cash flow will self-fund the rest of the drilling program.    

EV/MCF

With 1.152 TCF recoverable, and increasing EV for the to-be-assumed debt of $88m, the EV/MCF recoverable is still only 38 cents/mcf  ((352+88)/1152). 

Only the Australian CBM players trade that cheap, and that’s because they barely make money with first world cost structures leading to $1.80 per mcf lifting costs and gas glut pricing of approx $2.50 per mcf.    India, in contrast, offers third-world lifting costs under $1.00 per mcf, and pricing over $7… allowing $6 netbacks, versus 70 cent netbacks in Australia.  

Clearly these reserves shouldn’t trade at comparable prices, and if it is a third world discount you’re concerned about remember that India is a full Parliamentary Democracy with a strong legal system, property rights, and a government that’s hell bent on providing enough energy to feed their rapid economic growth.  Officials from the Ministry of Petroleum & Natural Gas have publicly stated that the build out of energy infrastructure is India’s top priority on numerous occasions.  

EV/EBITDA

On run rate EBITDA, GEEC looks expensive.  However, GEEC is fully funded to grow EBITDA to ~$200m over the next 5-6 years without equity dilution.   There is no exploration risk and low operating risks.  Plus there are huge government provided kickers to augment these cash flows…

Carbon Credits – kicker1

A big government incentive is designating GEEC’s CBM projects as eligible for Certified Emission Reduction (CER) credits related to the Kyoto Protocol’s “Clean Development Mechanism” for developing countries which allows them one credit for each tonne of carbon dioxide not emitted.  There are two types:  Methane Avoidance Credits (taking methane out of the coal which makes it safer for miners to eventually access the coal), and Carbon Emission Reduction Credits (by helping industrial users reduce emissions by switching from coal to natural gas).   A UN body is currently deciding how to allocate the avoidance credits which technically cannot be cashed in until the coal is mined which could conceivably be 20 or more years hence.  By 2009 it expects to decide on proposals of how much discount should apply for current use.  Eventually, once GEEC is selling to large industrial users, the company estimates they will generate two million of these credits a year…  see the EMIT function on Bloomberg… Current prices are EUR €22 per credit which would be €44m or $64m of entirely free cash to the company per year on top of the operating ebitda… no joke.   Mr. Modi sent his son, who is an executive at the company, to the UN Climate Change Conference held in mid-December in Bali where a main topic was these types of credits.

Seven Year Tax Holiday – kicker2

To attract investment and hurry along development the government gave out a tax holiday.  GEEC pays no tax for seven years after the point it declares commercialization.  GEEC declared for its first group of wells in July 2007, but each subsequent grouping of wells will have its own start date for a tax-free seven years.  Don’t underestimate how valuable this is…  Their taxes don’t begin until July 2014 and only then does it start in stages according to the drilling program. 

New Acreage

Another government New Exploration Licencing Plan or “NELP” auction is planned for additional CBM sites around India and the company is expected to bid.  Plus they will be looking to acquire adjacent land to their existing block to expand the resource base.

I feel this company is in good hands from both a managerial and shareholder perspective, with growing production, recovery rates likely to be higher than expected, a seven year long tax holiday, carbon credits, and is still largely undiscovered. 

Catalyst