Green Dragon Gas update

Green Dragon Gas (GDG) recent operations update points to bullish developments on both the upstream and midstream/downstream fronts. Particularly encouraging is the progress being made on drilling and CBM production Significantly, production has been in line with our expectations in recent months, while GDG’s 2012 year-end annualised exit target of 2.5bcf is modestly ahead. Assuming the progress of recent months is maintained, we remain confident that GDG’s 18bcf target is achievable by mid-2015.

Operations: Production Gathering Pace
CBM production has gathered momentum in recent months with an end-October annualised rate of 1.95bcf, up 17% from end-June. This is being driven by increased LiFaBriC drill activity with 49 LiFaBriC wells now in operation at GSS, a gain of 145% from a year earlier and 96% from end-June 2012. With continued progress GD expects its annualised rate at 2012 year end to be 2.5bcf. The company is also establishing a three-channel distribution system for its gas. Presently, practically all gas that is not flared is either sold as CNG or used internally as gen-set fuel. Following completion of a tie-in, GDG has started trial shipments to PetroChina’s West-East Pipeline. Significantly, CNG distribution capacity has been sharply increased in recent months, while CNG retail sales rose 60% between end-June and end-October 2012.

Board Strengthened
GDG significantly strengthened its board recently with the appointment of Wayne Roberts as non-executive director. Mr Roberts was most recently SVP Commercial at the BG Group and brings a wealth of experience of developing oil, gas and powe businesses across Asia.

Financials: Unchanged
We maintain our EBITDA forecasts for 2012 and 2013. However, the progress operationally, reflected in the recent update, considerably increases our confidence in the forecasts and we believe there may be scope for positive surprises in due course. The scale of the industrial project that GDG is undertaking continues to suggest a heavy funding requirement of over $200m in 2012/13.

Valuation: £7/share
GDG has trended broadly flat in recent months and continues to sell at a discount to book value of £2.9/share, suggesting very depressed expectations. We maintain our valuation of £7/share based on a sum-of-the-parts calculation.

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