Interactive Investor

Algy Cluff predicts North Sea coal bonanza

11th July 2014 13:25

Harriet Mann from interactive investor

Commodity investors seeking North Sea exposure typically turn to the oil and gas majors and second-string explorers, not the minnow trying to un-tap the energy potential from offshore coal. But mention oil industry legend Algy Cluff, and the ears of even seasoned investors prick up.

Best-known as a pioneer of North Sea oil in the 1970s, Mr Cluff is busy again. He's set on exploiting the energy potential from the thick bed of coal deep beneath the seabed through a process called Underground Coal Gasification (UCG). His latest venture, Cluff Natural Resources, has now been awarded five near-shore licences and some analysts believe the potential is massive.

Few bet against Mr Cluff. After discovering the Buchan Field in the North Sea four decades ago, Cluff turned his hand to mineral exploration in Africa before branching out into alternative energy through CNR.

"This all started many years ago when I was looking for oil in the 1970s," Cluff told Interactive Investor. "I realised how much coal there was in the North Sea, but, because I was looking for oil, thought no more about it until I came back from Africa a couple of years ago and thought that in light of the energy problems we have here...and the huge concentration of energy, the coal merited examination."

The UK is in a "chronic" energy crisis, Cluff says, due to declining North Sea reserves and an increasing reliance on gas imports. While he admits there is no "silver bullet" to solving the problem, he believes that he holds an option that could provide "enormous" consequences for the UK - deep UCG.

"It is quite a dangerous situation for the country to find itself in," says Cluff. "There is a massive energy deficit and we see ourselves as going a long way to meet that energy shortfall."

When you are dealing with fossil fuels, you are dealing with campaigners, but it [UCG] is certainly less controversial"Algy Cluff

And while some investors may be cautious about the upcoming Scottish referendum, the oil baron believes that CNR could be even better positioned to succeed if the Scots vote "yes".

"I think it will be easier. Scotland will have an energy problem, it probably has one now. They may be more ruthless in addressing the planning issues, because at the moment they have got depleting revenues from the North Sea, so I am not saying this is a solution, but it will have a major impact on Scotland's future," he says.

When the worm turns

As well as being relatively clean - it's a frack-less process - Cluff reckons there are limited exploration risks with deep UCG. That's because similar projects are already being conducted onshore and the technology is "well-established". "When you are dealing with fossil fuels, you are dealing with campaigners, but it is certainly less controversial. In fact, I would not know what is controversial about our gasification process," wonders Cluff.

The deep UCG process involves oxidising the un-mineable offshore coal to produce gas, CNR's finance director Graham Swindells explains. An ignition well sends down the oxidant in the form of oxygen and steam, and the gas produced is brought to the surface through the production well.

The product of the gasification process is syngas (synthetic gas); a mixture of hydrogen, methane, carbon monoxide and carbon dioxide, with the hydrogen and the methane being of primary interest, particularly for industrial customers. The UCG process enables as much as 80% of the coal's energy content to be recovered for different commercial uses like power generation and fertiliser production. Although there is no open market for the product, Cluff plans to either sell the syngas as a single product, or strip it down to its main properties.

However, arguments have arisen claiming that deep UCG has not had enough testing. Cluff puts this down to the energy "crisis" being relatively new and the complacency of oil and gas majors.

"The bigger the company the more lethargic and unimaginative they are," says Cluff. "In the early days of North Sea oil, the oil fields were discovered by the small companies ... It wasn't for five years after that that the oil majors surfaced. They have got no drive or imagination; they wait for someone else to do it."

This has influenced CNR's strategy - to obtain as much acreage as possible so that "when the worm turns", majors will have to go through the AIM-listed company to access UCG.

Panmure Gordon analyst Jack Allardyce agrees that while the process is yet to be widely implemented, the technology is well understood and has been developed over a number of years.

Economic sense

Over the last year, CNR has been awarded a handful of five-year licences for deep UCG covering nearly 31,000 hectares - Loughor Estuary, Dee Estuary, North Cumbria, Kincardine and Largo Bay - the latter two being in the North Sea, and all of which were "carefully selected on the basis of location, coal quality, seam thickness and prospectively for commercial development."

While all the licences are offshore, they run from where the land meets the sea and, thanks to the developments of directional drilling, UCG can be conducted commercially and at depth, making the process cheaper. Like the oil industry, one hole can produce a significant amount of energy, says Cluff.

Most importantly we know we can produce gas on a very competitive basis and much cheaper than other forms of energy"Algy Cluff

A typical project is expected to produce around 175 Million Standard Cubic Feet (MMscf) of dry syngas - enough to meet the annual gas needs of 270,000 homes - as well as 56MMscf of hydrogen and 30MMscf of methane a day, sufficient to power a 300 megawatt (MW) combine cycle power plant. Panmure Gordan expects a typical project to generate $3 billion (£1.8 billion) of revenue over the 25-year life of the project.

"Most importantly we know we can produce gas on a very competitive basis and much cheaper than other forms of energy. We proposed we will sell it at what we see as a significant discount to the price of natural gas. We are assuming a price of $6 per gigajoule (GJ), versus natural gas which sells at roughly $8/GJ, so a 25% discount." Swindells reckons the syngas can be produced all-in at $2.50 a GJ.

"We believe our model is robust, everyone has a different view on what the continuing growth of the US shale market is going to do to gas prices in Europe. It would have to fall quite dramatically for this not to make economic sense."

CNR will need $115 million for one project - £15 million to build the demonstrator and £100 million to get it up and running. However, operational expenditure will be "relatively low", it says.

True, CNR has a lot of money to find, but it remains confident it has enough shareholder support and enough potential for joint venture projects. It has already raised $2 million, and finance at this stage will inevitably be more equity based. But Swindells is quick to reassure investors that "until we have a number of different partners to speak to... we would never be seeking to raise the sort of numbers we have spoken about from our existing shareholders, that would be done with a fairly major multinational company that has been farmed into our licences." A farm-in deal where a 50% stake is exchanged for 100% development costs and possibly back costs, is the preferred option. CNR has already started to engage with industry players.

Timeline

To get comfortable with the structure of the coal bed, geological modelling will take place and help define a JORC (industry standard) coal resource. Once it has picked its first site, CSR will begin a "hefty" environmental component and engagement programme, probably in the fourth quarter of this year. Swindells says the latter is "critically important to ensure we do not make the same mistakes as some of the shale operators have made. Most people would recognise that the shale industry could have done better in terms of its PR."

The planning application is expected to be submitted at some point in the first half of 2015, with a significant period of building the demonstrator to start when this is given the go-ahead, with commercial production set for 2017.

It is because of this vague time scale that Panmure Gordon analyst Allardyce heavily discounted his valuation of the company, with the 13p target price representing just 10% of the net present value. "As the company progresses its licences we would expect to unwind this towards our un-risked 130p (£200 million) valuation," he says.

However, he adds, "with a significant portfolio of highly prospective near-shore acreage, we believe that the company is well placed to deliver significant value accretion," rating the stock a 'buy'.