Australia | Aug 05 2006
By Greg Peel
FN Arena’s feature story of 13 July, “Will Coal Replace Oil?”, has sparked significant reader interest. Having been developed early in the twentieth century, coal-to-oil conversion is only now being given close attention by a world reeling from high oil prices and talk of dwindling reserves of crude.
Using technology originally utilised by Hitler in World War II, even “waste” coal can be converted first into gas and then into liquid fuels, particularly diesel and jet fuel. South Africa’s Sasol has led the world in recent technological development, and US companies have thrown their money behind projects as well. One small Australian company, Linc Energy (LNC), is also at the forefront.
Linc has been tinkering with coal conversion at its site in Chinchilla in Queensland for the past six years. In May, the company made a small initial public offering, raising $22m to take the company into Stage One of its production plans. At an issue price of $0.25, the shares have not yet attracted particular secondary interest, trading at around $0.19 at present.
Stage One is only a small precursor to Stage Two, for which the company plans to raise a further $650m, mainly through debt.
Linc’s plan is to commercially produce “ultra clean” diesel and jet fuels through a two-step process. First the coal is converted to gas while still underground, known as underground coal gasification (UCG), and then processed in a gas-to-liquids (GTL) facility above ground.
The Stage One precursor involves the development of a 5 barrel per day (bpd) “demonstration” plant. In Stage Two, a commercial level plant will be constructed with a target of 20,000bpd. By first building a demonstration plant Linc hopes to satisfy potential investors that the technology is all it’s cracked up to be (pardon the pun). In the past six years Linc has demonstrated cost effective and efficient production of gas through UCG.
The next step of GTL will be developed with the co-operation of US-based Syntroleum Corp, with whom Linc has signed a memorandum of agreement. Linc will adopt Syntroleum’s own twenty-first century improvements on the Fischer-Tropsch technology for GTL, first used by Hitler. Syntroleum has an option for equity participation in Linc’s projects.
As well as a memorandum of agreement, Linc also has forward licensing and offtake arrangements in place with Syntroleum, as well as with BP Australia and Ergo Exergy Inc (Canada). Stage Three of Linc’s business model is the expansion of the UCG and GTL production process into global markets.
The GTL part of the process involves technology that is currently being implemented in various projects around the world, and its integrity has now long been established. Royal Dutch Shell, Exxon Mobil, Chevron, Conoco Phillips and Syntroleum are all in the process of building pilot projects. Sasol is currently providing around 25% of South Africa’s fuel needs.
The UCG part of the process is a different case in point. Linc’s project has been under development since 1999 and is the first project in the Western world to implement it. Ergo Exergy is a leader in the technology and is partnering in the development. The technical director is a Russian scientist who had been instrumental in the Soviet UCG program for 25 years. Sort of adds a whole James Bond feel to it I think.
The biggest advantage of UCG over other coal-to-gas conversion methods is that it happens right in the virgin coal seam. There is no need to actually get the coal out of the ground first. What’s more, the Chinchilla project is exploiting a coal source previously considered “stranded”. In other words, the coal is there, but it is not commercially exploitable using traditional methods.
The fact that the GTL plant will be located right on top of the coal source also provides Linc with a unique set-up. In most cases the coal is transported in. Having the gasification process occurring underground also provides significant environmental benefits.
One of the drawbacks of coal-to-oil conversion is the production of large amounts of carbon dioxide as a by-product. While the resultant oil products are much cleaner than their traditionally-cracked counterparts, the production process is not in itself providing much in the way of a carbon credit. Moreover, the resultant units of energy output are only marginally greater than the units of energy input required.
According to Keith Allaun, General Manager (Human Resources) at Linc, the company’s liquid fuel production process will be five times more energy efficient than a standard coal-burning power station. The process also allows for the carbon dioxide by-product to easily be captured in the UCG stage of production, and then be reformed into carbon monoxide and ultimately diesel. This technology is already commercially available and Linc has “the world’s best process engineers” consulting on the project.
Linc has a soundly established environmental impact agenda. Were carbon credits to be ultimately securitised in Australia, Linc would be “a big winner”.
Stage One – the demonstration stage – is planned to be running for another fifteen months before the financing required for Stage Two is sought ($650 million). Presently Linc is anticipating an 80/20 mix of debt and equity. It is expected the first commercial production will commence three years from now.
Chinchilla has an estimated coal deposit of 300Mt, although proving has only been completed to date for 16Mt. That proving process is currently ongoing. Linc lays claim to another 12-16 potentially viable sources in Australia and exploration is continuing. Some of these are suitable for UCG, but some are not.
Linc plans to become a world leader in coal-to-oil conversion using UCG/GTL. One company which is very interested in Linc at the moment is Sasol. Keith Allaun notes that current estimates suggest (at current rates of usage) there are 1000 years worth of “stranded” coal reserves in the world.
The only stock broker to provide a research report and recommendation to date on Linc Energy is BBY. The analysts have valued both stages of Linc’s project development using a discounted cash flow (DCF) valuation. They have also made more conservative assumptions than those provided by Linc.
Linc assumes a weighted average cost of capital (WACC) of 13.1%, BBY has assumed 15%. Linc assumes a long term oil price of WTI US$45/bbl, BBY is assuming US$42/bbl.Linc assumes a long term exchange rate of US$0.75, BBY is assuming US$0.70. Linc has now assumed a debt/equity ratio for the second raising of 80/20, BBY is assuming 60/40.
BBY also assumes that if the Stage One demonstration plant progresses successfully and according to plan, the market will continue to “de-risk” Linc Energy. Hence the analysts assume the stage two equity raising will be conducted at $1.00ps. (First raising was at $0.25ps). On this calculation there will be around 580 million Linc Energy shares on issue after placement.
BBY has arrived at a fully diluted DCF valuation of $1.52ps. The analysts recommend Buy.
BBY has set a 12-month price target of $0.71. The shares are currently trading around $0.19. BBY envisages that re-rating of the shares will occur once the proving up of the coal resource is completed, once the necessary personnel have been secured to achieve construction of the demonstration plant and beyond, and once the demonstration plant reaches significant milestones.
This is an innovative project. There are risks enough associated with energy production companies that have long been involved in traditional forms of energy production. Production delays, cost blow-outs, infrastructure constraints, financing difficulties – the list goes on. And we are also talking about oil – who knows what might happen in either the short or long term future.
Potential investors are advised that this is a speculative stock and should be treated cautiously as such. It would be prudent to contact your broker, or speak to Linc Energy directly, before making any investment decision.
