The companies agreed to expand a system to recover groundwater and build a slurry wall to keep coal byproducts out of water.
"This is definitely a great step forward for protecting clean water, especially in this area of the state," said Rachele Huennekens, a San Francisco-based spokeswoman for the Sierra Club.
The companies also agreed to fund several projects aimed at improving water quality in the area. The projects include river restoration efforts on the Navajo Nation, a regional microbial source study and a selenium reduction study.
Mine operator BHP Billiton New Mexico Coal Co. and power plant operator Public Service Co. of New Mexico agreed to the settlement, filed in U.S. District Court in New Mexico. It must be approved by a judge to take effect.
"While we disagree with the suit's allegations, we recognize there is value in a settlement that avoids further litigation and provides additional environmental benefits," PNM Resources chief executive Pat Collawn said in a prepared statement. "Rather than litigating the case, it is more prudent to settle and use the funds to invest in an additional water recovery system that would augment the current system and add value and functionality."
The settlement amounts to an estimated $10.2 million, PNM said.
The settlement will not affect operations at the mine or power plant, said Frederick Bermudez, a PNM spokesman.
"This settlement doesn't require any change in any way to how the coal is mined and handled," he said.
Bermudez denied allegations that coal waste is polluting water near the plant.
"We do disagree with their contention that there's contaminated water," he said. "There's no data to support that."
San Juan Mine is the sole provider of coal for San Juan Generating Station, an 1,800 megawatt coal-fired plant owned by PNM and eight other utilities. The mine was the site of a fire in September that halted coal production for weeks.
"We believe that this settlement demonstrates our commitment to being transparent about our operations and to working cooperatively with a wide range of stakeholders, including environmental groups, to address their concerns," Jac Fourie, president of New Mexico Coal, said in a prepared statement.
The Sierra Club filed suit in 2010 to protect water quality in the Shumway Arroyo, at the mine's southern boundary, which flows to the San Juan River, Huennekens said.
The recovery system will intercept the flow of contaminated water and restore the natural dry character of the downstream arroyo, she said.
San Juan Coal, a subsidiary of the Australia-based mining giant BHP Billiton, performed extensive groundwater testing in and around San Juan Mine as part of the settlement, Fourie said. A Sierra Club scientist was present for the tests.
"While we are confident that the coal combustion byproducts are not coming into contact with alluvial groundwater, the groundwater recovery system gives us and the community certainty that our operations will have no adverse impacts on groundwater," Fourie said.
The Sierra Club is part of an effort called New Mexico Beyond Coal that aims to end coal-fired power production in the state in favor of alternatives.
Huennekens encouraged PNM to "take responsibility for this in a larger way."
"There's still more coal being burned and mined every day, and that's dirty coal," Huennekens said.