Reece Straker, GlobalData’s Upstream Fiscal Analyst, takes a global view on the growing CBM industry.
While coalbed methane (CBM) development has been ongoing for many years in countries such as the US and Australia, others such as China have made concerted efforts to increase CBM production over the last decade, to dramatic effect, in step with demand for natural gas. Others are still evaluating undeveloped CBM resources. This difference in industry development means that the level of incentives on offer for investors is varied. While some countries no longer need fiscal support to encourage development, others are trying to find the right combination of incentives to overcome obstacles posed by a lack of infrastructure and expertise.
The US is the global leader in CBM development and production, and its mature industry means that the necessary infrastructure and expertise is already in place. Development costs are much lower than in areas where the CBM industry is still nascent and so less state support is needed to ensure profitability. As the industry has developed and gained momentum, the state has removed incentives to partake in revenues. The biggest example of this was the federal Section 29 tax credit introduced as part of the Windfall Profit Act of 1980 that was allowed to expire at the end of 1992. It was responsible for huge development progress and arguably spurred the US CBM industry to its current global position. Many years of continued development then convinced federal and state governments that fiscal support was no longer needed. In the largest producing states, Colorado (1216 million ft3/d in 2013), New Mexico (975 million ft3/d) and Wyoming (907 million ft3/d), CBM is treated together with conventional natural gas when it comes to taxation. Mississippi on the other hand, where there is currently no CBM production, still provides a fiscal incentive in the form of a reduced severance tax.
As the second largest producer of CBM, Canada has a strong industry, but huge in-place reserves mean that there is upside. Production is focused in Alberta and British Columbia, both of which provide incentives in the form of royalty programs. Alberta offers an extended new well royalty rate of 5% to CBM wells, compared to rates of 12-27% for ineligible wells. Instead of the usual one-year reduced rate applied to a maximum of almost 8000 m3 for new wells, CBM wells receive the reduction for three years to a maximum of just under 12 000 m3. Additionally, CBM wells can still qualify for the Natural Gas Deep Drilling Program (NGDDP), a general incentive designed to support high-cost gas. In this case, the deep-well royalty discounts are applied once the 5% new well royalty rate finishes. British Columbia has applied a royalty reduction factor to the rate applicable to CBM wells since 2002, reducing the rate payable based on monthly well production rates of up to 17,000 m3. On top of this, a royalty credit is available for wells on crown lands and freehold lands of CAN$50 000 and CAN$30 000 respectively.
Although not as large a producer as Canada or the US and despite having modest reserves, Australia’s CBM production is significant. Its industry is developing successfully, indicated by planned CBM to LNG projects. There are few fiscal incentives provided for CBM production, especially in New South Wales and Queensland where almost all of the production is located. Queensland, which has the most reserves, has not implemented any incentives but the industry has thrived. There are several reasons for this, including high gas prices in the region, planned LNG developments, and relatively favorable geological conditions. Until 2012, New South Wales provided a five-year royalty holiday on all petroleum production, including CBM, but a progressing industry in combination with increased pressure from taxpayers meant that the government no longer deemed it necessary. It is likely that the royalty holiday had a very significant impact on the development of the industry as it was applied on a per-well basis and production from CBM wells generally peaks well within this timeframe. Of the other Australian states looking to develop CBM resources, Victoria is the only one offering a fiscal incentive; CBM is subject to a mineral mining royalty rate of 2.75% instead of the usual 10% for petroleum.
Aspiring CBM industries
China, India, Indonesia and Russia have significant CBM reserves, but exploitation of the resources has been slow to progress. This early stage of development and associated barriers to entry means that fiscal incentives are of greater importance.
In India, the fiscal regime applicable to CBM is similar to the PSA offered for conventional areas, but with some key differences. The profit-sharing formula is very similar in format, but, significantly, the variable upon which it is based differs. While for conventional blocks, the variable used to calculate the government’s share is the investment multiple, the ratio of the cumulative revenue for the licensee, net of upfront payments and operating expenditure, to cumulative capital expenditure, the CBM regime uses a simple average daily production level, hence its name as a production level payment. Most significantly, however, is the fact that government’s share of profit, which is the result of the bidding process, is generally much lower for CBM than for conventional blocks. Another key difference is a seven-year tax holiday provided for CBM areas awarded in the fourth CBM bidding round.
In Indonesian PSAs, the First Tranche Petroleum (FTP) is offered at 5% for CBM projects as opposed to 20% for conventional gas fields. FTP is an amount of gross production that is set aside to be shared between the government and licensee before any cost recovery. It is shared equally between the two parties and therefore there is essentially a much higher 95% cost recovery limit and a small 2.5% royalty. Secondly, the profit-sharing rate is much more favorable to the licensee; post-tax licensee shares for CBM are around 40-50%, compared 15-30% for conventional areas. Nevertheless, profitability is not assured due to the high development costs caused by the country’s fledgling industry, which simply does not have enough service capacity or expertise for extensive CBM development yet. For pioneer investors, confidence is needed that sale prices will not be so limited domestically, or the produced gas may be exported. Until the industry is more developed, the price will need to be higher or more incentives provided to offset the inflated costs.
Although China has had CBM production for years, the industry has not taken off. The government currently provides a subsidy at a rate of RMB0.2/m3, possibly increasing to RMB0.4/m3 in the near future. VAT rebates are also available and import duties are waived on related equipment. Additionally, China has used regulations to attempt to encourage industry development, such as requiring co-operation between coal mining companies and gas producers, and ensuring that CBM production occurs prior to coal mining. Although increased subsidies and fiscal support would improve project profitability, a major obstacle to development is the inability to reach markets through a lack of infrastructure and limiting regulation. Until there is both the freedom and the capability to fulfill demand, the restricted sale prices will limit profitability and in turn investment in the technically difficult environment, requiring greater fiscal incentives.
Russia’s large conventional gas resources mean that CBM development was not pursued for a long time. However, due to the country’s huge coal reserves and significant if not relatively modest production, the environmental impact and safety concerns of coal-mine methane have gradually become big drivers in the government’s desire for development. The CBM production itself does not lend itself well to exportation due to the smaller average field production levels in comparison to the large conventional gas fields not validating large transportation infrastructure. Instead, CBM production is used locally for industry and local populations, freeing up more conventional gas production for export. In 2011, after pressure from Gazprom, Russia added CBM to the Russian Classified Index of Natural Resources and Underground Waters, which meant that it could provide targeted fiscal incentives such as exemption from mineral extraction taxes. In fact, CBM is currently not considered an object of taxation and therefore, not only is there no applicable MET; producers do not need to disclose any production data to tax authorities. Fiscal incentives are also provided to the mining companies that co-operate with oil and gas companies to produce CBM, such as deductions for necessary equipment and drilling activities on the MET payable on coal production. Furthermore, the improved safety and environmental impact for future mining activities means that further regulations aimed at co-operation between the two industries has the potential to drive Russian CBM development.
Effectiveness of incentives
When comparing the value of a representative CBM project across different countries, the investment proposition and level of incentive varies across the world. As can be expected, those with well-developed CBM industries have much less significant incentives on offer. Both the US and Australia have nearly non-existent incentives and in the significant producing basins, there are none for new wells.
It is also important to note that while the assessment applies a flat gas price across all countries to isolate the effect of the incentives, local market dynamics can significantly alter the economics of CBM projects. In Australia, India, Indonesia and China, the viability of CBM extraction is significantly increased by higher prices. This should particularly help growth of the Australian CBM sector, with more attractive economics than in the other established areas of the US and Canada.
The picture is more nuanced for areas where CBM is at an earlier stage. While Indonesia, China and Russia have attractive incentives, technical obstacles mean that their incentives are likely to have less of an effect on development. Although India’s combination of tax holidays and improved profit sharing dramatically increases project profitability, its regime still does not compete with countries that have significantly greater resources. This may mean that the incentives are not sufficient to spur widespread development.
CBM fiscal incentives have had varied success globally. Their effectiveness is highly dependent on other factors such as the status of infrastructure and the quality of reservoir. Where conditions are conducive to development and production, such as in Australia, minimal incentives can have the desired effect. Unfortunately, for other Eastern Hemisphere countries with CBM aspirations, more extensive incentives and regulation will be needed to overcome the initial infrastructure and technical hurdles in order to spur industry development.
Edited for web by Cecilia Rehn.