Island Gas goes with the flow

Having recently started supplying the National Grid with its first electricity generated from coal-bed methane (CBM), Island Gas Resources is well placed to exploit the growing demand for domestically-sourced energy. That reflects the UK's increasing gas supply deficit and a strategically unwelcome reliance on fuel imports. Moreover, natural gas is an abundant fuel that's cleaner than oil and coal, and currently provides about 35 per cent of the UK's energy. Indeed, almost two-thirds of new European power projects currently under construction are gas-fired.

However, the UK's natural gas supplies are under pressure. North Sea gas production is declining at an annual rate of 8-10 per cent, which has rapidly turned the UK from being a net exporter to net importer of gas. Much of the UK's gas now comes from Russia, but that's a potentially unreliable source. Indeed, contract disputes between Russia and Ukraine have resulted in many European countries suffering supply disruptions during recent winters, leading to calls for the UK to bolster its energy security.

That's good news for a domestic gas producers such as Island Gas Resources, which is focused on CBM-based power generation. CBM is a natural gas that has been trapped in coal seams by the pressure of underground water. Drilling wells to pump out the water releases this pressure and lets the gas flow. Admittedly, the UK hasn't made much progress yet in turning to less conventional sources of natural gas such as CBM, but it represents 10 per cent of domestic gas production in the US and 18 per cent in eastern Australia. Given the decline in North Sea fields, CBM could quickly become an important aspect of UK gas production. too.

Moreover, with its operating partner, Nexen - a leading Canadian CBM player - the group is also the most advanced CBM developer in the UK. It holds 1,756 sq km of licences concentrated in Staffordshire, Lancashire and Yorkshire. Many of these licences sit in the Cheshire Basin - that's not only prolific for gas production, but is also close to large urban gas markets which reduces transmission costs.

The group has already brought its Doe Green test plant in Cheshire into commercial production, and is now producing enough electricity to power around 1,200 homes. The company plans to bring a second Doe Green well into production before the year-end and there's also plans to begin developing a project at Swallowcroft, which will supply gas to Keele University.

Still, a big uncertainty facing UK CBM production generally is the reliability of gas flow rates from coal seams. The group's experience at Doe Green does provide some comfort here, but the company will need to drill further wells in order to prove flow rates over its wider acreage. Management plans to drill around five further wells over the next couple of years to demonstrate this - there was a £3.5m placing in July to finance this work. Success here should demonstrate that the company's substantial gas resource, of 571bn cubic feet, can be commercialised - potentially releasing considerable value. Although investors can expect the company to remain loss-making while that programme progresses.