Marginal wells a tipping point for industry

James Fenton
Tom Mullins, owner and operator of Synergy Operations LLC in Farmington, talks about proposed federal regulations for the oil and gas industry on March 11 at an XTO Energy natural gas well near Piedra Vista High School.

FARMINGTON — Hampered by low natural gas and crude oil prices and leery of pending revisions of federal regulations intended to tighten oil and gas industry regulations, San Juan County operators are making payroll cuts and closing wells as they struggle to keep running.

Tom Mullins, owner/operator of Synergy Operations LLC in Farmington for more than 20 years, has worked through previous bust cycles. But this one has had staying power and the loss of revenue from a reduction in severance taxes already has hurt local and state budgets, he said. And the proposed changes to federal regulations will multiply the negative impact, he added.

Mullins said that 75 percent of the natural gas wells in the San Juan Basin qualify as marginal, according to the federal government's measurement. Wells that produce fewer than 90 Mcf — an Mcf is a thousand cubic feet of natural gas — a day are classified as marginal. Older, low-volume natural gas wells in the basin produce an average of 35 Mcf a day, and are at risk of being temporarily closed if currently proposed federal rules, including the Bureau of Land Management's propose update of the venting and flaring rule, are finalized later this year, he said.

Twenty-five percent of the basin's natural gas wells are "cash-flow negative" at $2 per Mcf, according to New Mexico Oil and Gas Association spokesman Wally Drangmeister. Natural gas was selling on the commodities market for $1.85 per Mcf on March 16.

Drangmeister said an additional 12.5 percent of wells would qualify as "uneconomic" under proposed federal regulations that include the updated BLM venting and flaring rule. The BLM rule would require operators to retrofit their natural gas facilities with stronger pollution controls such as low-bleed pneumatic valve controls. He said it would cost, roughly, $5,000 per well to comply.

Drangmeister said the total — 37.5 percent of the wells in the basin — are at risk of being plugged or closed permanently by the double whammy of low natural gas prices and the impact of the pending BLM rule changes.

"Yes, this financial stress is severe. (Commodities prices alone) are making impacts on everyone who produces natural gas in the San Juan Basin," Drangmeister said. "If you’re temporarily shutting wells in, it's no small feat. You still have operating and maintenance costs with no revenue. (The cost of) these lower producing wells really add up."

And as operators cut production, government loses tax revenue. In fiscal year 2014, San Juan County alone delivered $349 million to the state's general fund. And, of that total, $45 million came from marginal wells, Drangmeister said.

Mullins said his company temporarily closed 15 percent of its production on March 1. Synergy is down to three employees. He laid off five workers over the last year, which allowed him to continue operating, he said.

And, Mullins said, the persistently low market prices for natural gas only makes the misery worse.

A price per Mcf is set monthly and daily on something called the "San Juan Basin Inside," which is regulated by the  Federal Energy Regulatory Commission, and generally sets a lower price that market prices, Mullins said. The March 2016 monthly price for natural gas was $1.52 per Mcf. The last time prices were lower was in October 2001, Mullins said, when an Mcf sold for $1.37.

Mullins is also Independent Petroleum Association of New Mexico board vice president, representing the northern half of the state.

The Roswell-based organization, with a membership of about 300 independent oil and natural gas producers, promotes education about the industry — especially the industry taxes and fees that go to the state's general fund — and promotes legislation that supports the oil and gas sector.

A recent bill sponsored by state Rep. James Strickler, R-Farmington, sought to offer oil and gas companies some relief, but it did not survive the 30-day session. Strickler's bill was aimed at adjusting Severance Tax and Emergency School Tax rates for oil and gas wells that produce fewer than 10 barrels of oil or 60 Mcf of natural gas per day.

But Mullins said the ultimate misery is still to come. The boom in shale oil production has had an impact on the natural gas market.

"This year is going to be, in my opinion — my crystal ball — the worst prices since I've been in the business, for natural gas," he said. "The main reason is supply and demand. Too much supply, not enough demand. People are giving it away. If you have an oil well and you have the natural gas that's with it and you want to produce your oil, you have to produce the natural gas. Do you really care what price you're getting for your natural gas? You just don't want to be flaring it or venting it or doing something that would raise even more government ire. So you just put it in the pipeline and sell it. And they say, 'We'll give you a dollar for it.' It may cost you $1.10 just to transport it. But you don't really care because at least you're selling your oil. If you have all these marginal gas wells, you shut them off. And that's the ultimate. You don't want to do that."

The first conventional well drilled in the San Juan Basin was in 1921, making it one of the oldest in the nation. It is now among the largest natural gas production zones in the U.S.

A majority of the basin's more than 20,000 oil and gas wells are 40 and 50 years old, which is why Mullins feels that, with the proposed regulations, the federal government should make an exception for wells that are considered marginal. The value of that gas is minimal, but the wells are still considered viable, Mullins said, because they continue to produce year after year.

Mullins crunches numbers routinely as an oil and gas company owner. He said applying the proposed rule changes to one marginal well over a 30-day period reveals the bottom line for smaller independent operators like Synergy.

A typical low-producing well in the San Juan Basin, selling its natural gas at the $1.52 per Mcf price, would lose hundreds of dollars a month, Mullins said. A smart operator would shut such a well down, he said.

The typical low-producing well generates $200 in federal royalties and $150 in severance and ad valorem tax revenue, which will be lost if the well is shut down.

"We lost money," he said. "In the rational world, we won't run a well and lose $600 a month. We'll shut the thing off. Because that's what rational people do. And when that happens, the royalty revenue goes to zero and the severance and ad valorem revenue goes to zero. Then you multiply that by 20,000 wells (in the basin) and they just go off."

Mullins said a temporarily closed well won't likely be reopened unless natural gas prices return to a $3 to $4 range.

"And every additional rule that you put on me that I have to comply with, venting and flaring and everything else, just raises that ($3 to $4) price up even further," he said.

And half of the production in the basin is from coal-bed methane wells, which are far riskier propositions, he said.

"If you cap that well, you have materially damaged it and harmed the well," he said. "If it was operating at 100-percent efficiency when you shut it off, you might lose 50 percent efficiency forever."

But Mike Eisenfeld, San Juan Citizens Alliance energy and climate programs manager, welcomes the new rules and said the industry is obligated to reduce pollution.

"The onus is on (the oil and gas industry)," Eisenfeld said. "I can walk in any direction from my house (in Farmington) and stumble upon any number of wells that have problems. It shouldn't absolve them of their responsibilities. And I think it's long overdue. What we need are solutions, not a refusal to even consider them."

Eisenfeld rues the "drill, baby, drill" days of the industry before the federal government began to update its rules to match the latest technology such as horizontal drilling.

Einsenfeld said he wants to see a willingness by the oil and gas industry to address pollution, not simply a push back against what operators perceive as punitive rules enacted without consideration for economic impacts.

"I do empathize, but at the same time, they're not supposed to be wasteful," he said. "There may be a good case for some wells (to be exempted) but to take a blanket approach and say, 'Hey, we're going to fight this' doesn't work for me. The trend is that the bigger companies sell off (older wells) to the smaller operators and the smaller ones say they can't afford it. That's been going on for a long while. We're just now finally starting to get a recognition that the industry does contribute to emissions of ozone, methane and hydrogen sulfide, you can go down the list. If some of these independent petroleum guys feel like they're being unfairly picked on, they should make the case for themselves."

Drangmeister is working to quantify the economic impact of the proposed rule changes on the state oil and gas industry.

He said the wells that aren't profitable represent about 13 percent of the total gas produced in the San Juan Basin each year. That number adds up to 69 million Mcf of the roughly 700 million Mcf produced in the basin per year.

"That’s a lot of gas," he said.

Drangmeister said his organization funded a $25,000 fiscal year 2014 study by the state Tax Research Institute — posted at nmoilandgas.com — to show how that production adds up to dollars that fill the state's general fund and supply the budgets of local governments each year.

In 2014, the state oil and gas sector generated 35 percent — or $2.1 billion — of New Mexico's general fund revenue, according to the study.

The cost of retrofitting declining wells to comply with the proposed changes — about $5,000 per well, on average, he said — represents more cost than the well's annual production is worth.

Mullins said more local operators likely will be capping wells or simply going bankrupt through the rest of the year.

And operators say the additional costs of stricter regulations will have a severe impact on the local economy and, ultimately, the state economy.

"It's tough and it's going to get a whole lot tougher," he said.

James Fenton is the business editor of The Daily Times. He can be reached at 505-564-4621.