Tax Credit Has Gas Men Drilling

FOR 40 years natural gas companies have been drilling wells - 18,000 of them - in New Mexico's San Juan Basin. For all those years and all those wells they drilled right through 3,000-foot-deep coal seams that contained methane, the main constituent of natural gas, to get at conventional gas-bearing formations below.

Now gas men are working those coal seams, thanks to a hefty tax credit that Washington will give those who move fast to develop coal seam gas. Wells have to be drilled by this year to qualify.

``This is a tremendous resource. It's only now dawning on the industry and the financial analysts how significant it is,'' says Warfield Hobbs IV of Ammonite Resources, a geological consulting firm in New Canaan, Conn.

Because development of this resource is new, evaluating its size is difficult. The industry generally accepts 90 trillion cubic feet (TCF) as an estimate of recoverable gas. But that's thought to be very conservative and doesn't include methane in several large coal basins. Even so, it already equals almost 60 percent of the proven conventional gas reserves of 157 TCF in the United States.

``Here is a resource that was considered unconventional 10 years ago,'' says Bob Kalisch, the director of gas supply and statistics for the American Gas Association (AGA). ``Something big is happening in the gas industry.''

This ``something big'' involves a lot of money. Mr. Hobbs calculates natural gas companies will spend well over $1 billion this year to drill 4,700 coal-bed methane wells. By year's end, 7,000 wells will be in place, located either in the San Juan Basin or Alabama's Black Warrior Basin, where the coal yields high volumes of gas and pipelines have already been built.

By the end of 1991, Hobbs expects total production from these wells to produce 1 TCF a year - 6 percent of annual US natural gas consumption of 18 TCF.

``With the deliverability of other gas supplies declining, coal-bed methane is going to play an important role in meeting any increases in demand over the long haul,'' says David Newman, vice president of Amoco Production Company in Denver.

All this from a gas that at best used to be considered waste, at worst, deadly.

Ever since coal started to be mined, likely by monks near Newcastle-upon-Tyne in 13th-century England, coal-bed methane has caused mine explosions.

Methane molecules bonded to the coal while it was forming millions of years ago. Water held them in place. Removing the water to mine the coal releases the poisonous gas.

Initially, drilling for coal-bed methane aimed only at improving mine safety, and the gas was simply vented into the atmosphere. But Amoco realized it could be commercial and sank its first coal-bed methane well in New Mexico in 1977.

Two years later, as it battled the energy crisis, Congress introduced a tax credit to subsidize development of nonconventional energy sources.

Amoco was pretty much alone until the mid-1980s. But as technology became available and the tax-credit deadline neared, interest in coal-bed methane quickened. By 1988 the rush was on.

``The tax credits are so favorable that they can dwarf the production economics and risk involved,'' says John Olson, natural gas analyst at First Boston Corporation in New York. ``That's 90 percent of the interest behind the intense drilling activity now.''

With the credit, coal-bed methane producers reduce their taxes, depending on how much they produce. The deduction, which continues through the year 2000, is calculated by a formula that includes inflation and oil prices and is now approximately 89 cents for every thousand cubic feet of gas. That can have the effect of raising gross revenues as much as 80 percent.

But only wells drilled by midnight, Dec. 31, will qualify.

``There is strong support in Congress for an extension of the tax credit'' qualification period, says Felix Sanchez, director of congressional relations for the AGA. ``But with budget negotiators struggling to reduce the federal deficit, they face tremendous pressure to find dollars wherever they can.''

If the credit is not extended, development will plummet, and this is not the only uncertainty.

The huge quantities of water pumped out of coal-bed methane wells are often contaminated. In Alabama's Black Warrior Basin, most of the water is released into rivers, usually after settling in holding tanks. Producers claim to meet environmental standards, but environmentalists are suing.

``We might see some brakes put on the this process because of the environmental aspects,'' says consultant Hobbs.

While the industry waits to see what happens, it's not standing still. By year's end Amoco will have invested $530 million in about 1,075 wells. Burlington Resources and Energen Corporation, of Birmingham, Ala., both plan to drill at least 300 wells each this year, while Transco Energy Company of Houston is funding a 200-well program.

Chevron Corporation of San Francisco, Atlantic Richfield Company of Los Angeles, Phillips Petroleum Company of Bartlesville, Okla., and dozens of independent companies also have substantial drilling programs.

``Coal-bed methane is prime time,'' drawls Houston-based Michael H. McKenzie, who heads family-owned McKenzie Methane Corp. In 1986 he was one of the first to join Amoco in developing coal-bed methane, and by the end of this year he will have spent $278 million on 789 wells.

``My employees gave me a black giraffe award at Christmas. Black for coal. And a giraffe because I stuck my neck out so far,'' Mr. McKenzie chuckles.