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Interview

with Robert Hockert, Country Manager, Far East Energy Corporation

13.02.2012 / Energyboardroom

Mr. Hockert, historically, some major energy companies—including Chevron and BP—exited China’s CBM sector in the early 2000s, citing policy constraints and low demand in the domestic market. Why did a small Houston-based enterprise decide to tackle what many would view as a challenging market?

Robert Hockert: I would begin by noting that most major CBM assets that are developed today are discovered by small independent companies—the fact that the majors pulled out does not necessarily speak negatively about the potential of the resource. At the time, gas demand was a shadow of the enormous demand that exists today, and then there were no pipelines and poor pricing. Today, demand is off the charts; pricing is very high compared, for instance, to US gas prices; and pipeline access is increasing although still challenging. Those same majors are now looking at China CBM again.

Far East Energy is a microcap company, which does not have a lot of money to work with. Therefore, we were very particular about coming to this market and very carefully evaluating what we had here and how we would develop it.

I joined the company having had experiences in the Powder River Basin and a number of other U.S.-based basins. When I first arrived in China, I believed that the geology would be very similar—it is not. It is completely different! The regulatory environment, too, is completely different. To me, it feels like starting something brand new. Nonetheless, some of the technologies that have been used for a number of years in the U.S. do apply in this region; they were not being utilized here, and we brought them in.

We first started really drilling in 2005, and we have since made a major discovery. We have applied for reserve qualifications, and we are pretty excited—we believe we have a great asset. It has excellent gas content in the coal. This is an investment in what we expect to be a long-term trend. China is ripe to duplicate the unconventionals success story in America. The country needs the fuel: with the dramatic expansion of the middle class, more and more energy will be required to sustain growth. The majority of energy in China is derived from coal, and that means there is more and more pollution. Therefore, any contribution obtained from unconventionals is going to be a benefit both to investors and China itself. We found this to be an attractive opportunity.

How has the sector changed with the impending rollout of the 12th 5-Year Plan for CBM?

There have been a number of various changes, and, on balance, I believe the sector has become more attractive for foreigners. However, China is now focused on CBM, and they have, to a certain extent, become our competition. For example, the principal state-owned CBM company, CUCBM, is very well funded and now wants to develop some of its own acreage. That puts a lot of pressure on service companies: there is a limited number of frack fleets, a limited number of drilling rigs, etc. Hence, we find ourselves in competition. They are a partner on our project; yet they are also a competitor because of this self-development plan.

There are a number of positive outcomes of the 12th 5-Year Plan, as well. For example, we anticipate accelerated pipeline development—and accelerated regulatory improvement, as there are still a number of regulatory problems in this segment.

How then do you ‘buy’ your staying power in China, when the Chinese are starting to themselves increasingly focus on CBM as you have mentioned?

Our staying power is really founded on our PSC, which runs to 2032. We have made a discovery, and to make an analogy to a U.S. concept, we are now ‘held by production.’ As long as we comply with the terms of our PSC, we can move forward—we have a large block and ten or more years of strong development ahead of us.

However, to obtain a new PSC would be very difficult in this climate!

Far East Energy is well positioned amongst its competitors because it has discovered an area of high-permeability CBM—unique thus far in China—on the premier Shouyang project, and is also the only Western player in the country to secure pipeline access for its CBM gas—a factor that has traditionally challenged your counterparts. How did Far East manage to achieve this favorable position?

We have three blocks here—Yunnan, Qinnan and Shouyang, and we are mostly focused on the latter. We have indeed discovered a very large area of high permeability in Shouyang that we believe will represent a turning point in the development of China’s CBM industry. China’s coals hold an enormous potential energy resource as they are very high in gas content; but tapping that gas resource has been difficult because China’s coals are notoriously low in permeability. As your readers know, it was the discovery of high permeability areas in San Juan, Powder River and other basins that led to the explosion of CBM in the United States and we hope Shouyang can do that for China.

With a potentially large play as a result of the discovery of high permeability, we needed the ability to hopefully one day move large gas volumes. Shouyang involved a six-month negotiation for pipeline access. In China, much of what you do is built on relationships: how you act towards your partners and local communities is immensely important.

We were fortunate in that there was a pipeline running directly through our block to start with. However, the negotiations were not without their difficulties, and were handled directly by our CEO. The bottom line is that we have the gas and China has the demand, and a need to feed that pipeline. At the time of the agreement, they were still looking for supply contracts. We were able to get a ‘take-or-pay’ contract, and have no minimum requirements to meet or any minimum volumes. We are quite happy.

Would you say that these are the spoils of getting in early?

Yes, I would agree with that. We were also simply fortunate to find ourselves nearby a pipeline. Most Chinese CBM projects go to CNG because of the lack of pipeline infrastructure. Ultimately, that can constrain sales. With a pipeline, we do not face that difficulty. We have access to a local, provincial pipeline, and our gas is sold directly to the city of Shouyang. In this way, we also help the local community.

As recently as this month, you announced positive results from three appraisal wells in Shouyang, continuing a streak of positive experiences from previous appraisal wells drilled in the block. Can you give our readers some further insight into the current status of your assets—and your strategy, timelines, and expected outcomes for commercialization?

First, our block goes from shallow to deep. We initially believed that there would likely be some point at which our block becomes too deep to develop efficiently. That is because generally, in CBM, the deeper you go, the less permeability you find in the coal resource—to the point where further development is uneconomical. However, we pulled some wells down to the southern part of our block—the SYS05 and SYS02 wells. These wells are approximately 1370 and 1275 meters deep, respectively. Surprisingly, we continue to find good permeability. Our plan, therefore, is to continue to probe the boundaries of where our block remains commercial. The only way to do that is to continue to drill appraisal wells throughout the asset. Our longer-term plan is to drill a matrix of exploration wells with a spacing of 4Km in a grid shape. Then we will able to map the entirety of the field very well.

At the same time, we will continue to drill production wells in our core area, where we have applied for Chinese reserves. We will feed our compressors and develop more and more gas for sales. Ours is a two-pronged approach.

As far as timelines—first of all, as I have mentioned before, we are a microcap company, so funds are an important issue for us. Securing funds should not be a problem, because the market is receptive, and also JV possibilities abound because of our pipeline access and high permeability. Once the funds are in place, the next target that we have to work around is the extension period. In that case, we work backwards: we know how many evaluations wells we need to complete to hold the block under reserve certification clauses, so we back-calculate how many rigs we need. We currently estimate about a 20-rig program for an extended number of years.

How has your relationship with your partners developed over time, especially given the reshuffling in recent years between CUCBM and CNPC?

Things have certainly changed. Firstly, the new 5-Year Plan changed the environment in a major way, and secondly, CNOOC came in as a 50% partner in CUCBM. They brought their own philosophies and management into the CUCBM organization, notching it up a level. CNOOC is used to working with foreign partners, and their involvement will probably lead CUCBM and us to be a little more aggressive in developing the block.

They oversee certain aspects of the project, but we still make the plans as the operator; we still perform the evaluation work, and simply report to them as a working-interest partner—although they are, of course, more than a ‘working-interest partner’ as we would think of the term in the U.S.: they have a bit more control. They still control, for example, certain compliance aspects of the project.

Nonetheless, we are the operator, and that is an advantageous position that allows us to bring foreign content in when we need to, and different technologies that Chinese companies do not yet have. This is their reason the Chinese commit to a foreign partnership, and it is something we are taking full advantage of.

We have heard multiple times that the Chinese have an approach of “if we can do it ourselves, we will.”

Exactly—we can see this in their self-development areas. A typical pattern is that they award certain blocks of to-be-determined potential to foreign companies for development. The foreign companies figure out the best practices, the best technologies—the best cookie-cutter way to develop—and the Chinese duplicate these approaches in their self-development areas. I believe that is their goal. This does not conflict with our development.

We have had a good partnership with the Chinese. They have offered their research institutes to evaluate our data, so that we could compare notes with our own evaluations. We have a JMC meeting at least once a year, but in addition to that, we have smaller technical meetings quite often. There is a wealth of data-sharing. I expect that there is a wealth of copying as well, but that is a measure of our successful approach to the project. I believe the Chinese bring the foreign companies in so they can expedite their own future developments by reapplying knowhow.

You have mentioned that acquiring additional blocks will be difficult—what then, is the development strategy of this company?

We certainly do not want to stagnate—however, these blocks will really keep us busy. We could be looking at thousands of wells, and that is only looking at Shouyang.

In the Powder River Basin, we would drill 300-1,000 wells per year. I cannot yet say whether we can duplicate that rate in China; the high side of that would certainly be difficult. First of all, the drilling process is different: the rocks in China are harder, and the resource is buried deeper. A 2000 meter well that would take 7 days to drill in the Powder River Basin takes about 15 days—minimum—in China. It can even take as much as 30 days, and we are speaking of 24-hour operations.

Notwithstanding geological difficulties, we have gone from a one-rig company in 2005, to three rigs in 2007 when I joined the company. Last summer, we had nine rigs operational. We are likely to expand to 15-20 rigs, and perhaps we will multiply that number further, depending on funding. That is exponential growth.

What is the best advice that you can give about being successful in China to your fellow expat managers?

I have also managed projects in Russia, and I have found that, no matter where you are, the internal strengths of the organization are key. Everything depends on the people that you bring in to the project. For example, you put your specialists into the field for 30 days at a time in a small environment, and if they do not have good people skills, the project will not work regardless of how good they are as engineers or technical experts. The first step is to build your company structure correctly, and that means putting the right people in the right places.

Once you get the right people, pay them well and don’t loose them. Avoid turnover as much as possible. Our own turnover has only been about 5%. Expat turnover has been quite low as well.

Western managers should also expect, as I have mentioned, that Chinese working conditions will be quite different from those they have seen in the west. For example, the same rig that usually is operated in the U.S. by six people on a 24-hour assignment will involve 50 people in China. The approach is different: in China it becomes a camp job, and there is a safety specialist, there is a mechanic, etc.

We have had arguments with our manpower contractors over just how many people they will need to provide for a job, and we will now be taking over the tasks ourselves—but we will still need more people than we normally use in the U.S. There are unique aspects of working with and near small villages, some of those being increased safety measures that we do not have in the West. There are also site security issues that we do not have in the U.S., and this requires an entirely different level of employment. But in the end, in China, we will comply with all the rules and regulations.

Is it difficult to adapt to these conditions as a manager?

It is definitely frustrating—because you do not calculate these things into your economics, as you have never seen them before.

What is your final message to the international readers of Oil & Gas Financial Journal?

China Coalbed Methane can be a tremendous investment opportunity. There are pitfalls here and you must be careful in China, dealing with CBM. With correct stewardship through the process, companies can be very successful in this country, especially given its future growth potential and its developing middle class and CBM will be a critical element of gas supply once other high permeability fields are discovered. For now, we feel blessed and gratified to have made the high perm break through.

Mr. Huff, can you shed some light on your efforts to raise capital, your shareholding structure, and the value that this company offers its shareholders?

Bruce Huff: It is always a challenge, in our industry, to develop cost-efficient capital at each stage of one’s life as a living, breathing, oil and gas entity—particularly in the exploration and production arena. At our Shouyang project, in particular, we are continually enhancing and increasing our level of activity. We also find that the industry in China is presently very focused on the unconventional gas segment, and specifically aggressive in coalbed methane. Moreover, the price for natural gas in China is well above the price in the U.S.

We have before us a truly standout opportunity, and we are quite encouraged by our prospects. Our shareholders, to a significant extent, are large institutional entities and several of them are well-known around the globe. We are very fortunate to have investors of such caliber, and thankful for their support throughout the past years.

Coalbed methane exploration is a bit of a different operation than traditional oil and gas E&P. It has its own challenges and its rewards. It is a longer-term play, and that is something to anticipate and understand going in. We are about seven years into our own efforts in China, so we are actually becoming more mature as far as bringing about not only discovery of the resource, but also moving toward development of the discovery at the Shouyang Production Sharing Contract acreage.

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