Analysis: The potential economic impacts of a Methane Rule

John R. Moses
Farmington Daily Times
George Sharpe, Merrion Oil and Gas investment manager

The first order of business for Michelle Lujan-Grisham, New Mexico’s new governor, has been to issue an executive order calling for a Methane Rule.  At first blush, this rule seems to make total sense, as capturing lost methane means lower emissions and more revenue for everybody, doesn’t it? The reality is that the Methane Rule will be a double-edged sword that if not properly implemented, will actually result in significant reductions in overall revenues to the state.  

Before we look at the math behind the money, let’s look at a couple of things that methane rule will not do, no matter what the proponents claim.

Here is a view of the Four Corners methane hotspot.

Methane hotspot

The Methane Rule will NOT significantly reduce the methane hotspot over the Four Corners.   That is because the hotspot is primarily due to natural emissions from the Fruitland Coal outcrop, not from wellsite emissions.   There are some 30,000 wells with old emission technology in the San Juan Basin, but there are hundreds of thousands of such wells in each of the Permian, in Kansas, and in Appalachia.  If the wells were causing the hot spot, you would have much worse hotspots over each of these regions.  The one thing the San Juan Basin has that they don’t have is an exposed outcrop of a major gas bearing coal along the NM – Colorado border, which is right where the hotspot is focused.

A drill site in Farmington is seen with Piedra Vista High School in the background.

Air Quality near Well Sites

The Methane Rule will NOT dramatically improve health conditions around well sites because conditions around well sites aren’t dangerous to start with.   Methane itself is not harmful to human health.  While there are minute constituents in the gas stream that at high enough concentrations could be harmful, they don’t get anywhere close to those concentrations even at the emission source, much less a few hundred feet away.  

The City of Farmington has over 250 existing wells with old separator technology inside the city limits.  Those of us here grew up around them, played baseball next to them, and went to school next to them our entire lives.  NOBODY is in danger that these wells are emitting a puff of gas the five or six times a day the separator valve dumps to the tank.

San Juan Basin production rates by well.

San Juan Basin New Mexico well count

There are some 26,000 active wells on the NM side of the San Juan Basin. The attached graph shows the production rate for all those wells, from the lowest to the highest. Over 20,000 of those completions produce less than 2700 MCF/mo, the level at which the IRS considers them to be marginal. If the Methane Rule requires significant capital retrofitting of these old, marginal wells, many will just be plugged out. Here’s why.

Individual monthly well cash flow

The economics of a well

The chart below compares the revenue and expense for a typical 45 MCFD (1350 MCF/mo) well at a current San Juan Basin gas price of $2.30/mcf. The Operator makes $3105 per month in total revenue, and pays all of that out and more. The landowner (State or Fed or Private) receives $388 in royalties. The State and County receive $283 in taxes.  

The pipeline gathering company makes $405 in gathering fees, which pays for their people to operate and maintain the system (ie jobs).  And the operator pays an estimated $2200 per month in operating expenses (based on Merrion’s average), which pays for all kinds of things (i.e., jobs), from the pumper to rental compression to maintaining roads to parts and maintenance to the back-office accounting folks who push the money from one side of the equation to the other.  

The bottom line is that there are a LOT of people making a living off operating a marginal well, even if the Operator is not one of them. Further, the $69 per month of potential revenue gain if the methane were captured is not going to turn this well into a money maker, and would take almost 20 years to pay out the capital investment.  
So why would an Operator continue to operate a well at a loss?  Oddly, we ask ourselves that all too often. There are a number of combining factors, from having pumpers on the payroll and wanting to keep them employed, to hoping to limp along until prices improve and we actually can make a profit, to wanting to put off the cost of plugging the well to another day.  

What usually causes the Operator to finally throw up his hands is something breaks, requiring some sort of capital investment.  Rather than putting that money into repairing a well that is losing money, the Operator will put it towards plugging the well. Therefore, if the Methane Rule is written such that it requires retrofitting old production equipment, it will indeed be the proverbial nail in the coffin.    

The cumulative economic impact

Let’s assume that we plug out the 13500 some wells that are producing less than 1350 MCF/mo, and retrofit the 12,400 higher producing wells, capturing 30 MCF/mo per well in lost methane.  On an annual basis, that new revenue would generate $1.3 million per year in royalties and another $0.9 million in taxes. 

That sounds like a lot of money, but it doesn’t begin to compare to the revenue lost from the plugged-out wells. On a cumulative basis, those wells were paying $29.7 million per year in royalties and $18.8 million in taxes. Even more devastating, particularly to San Juan County that is already suffering huge job losses in the coal industry, would be the loss of another $380 million per year in jobs and services that are associated with operating those wells.  

It's a climate change issue

The bottom line is that the Methane Rule is not about increasing revenue.  I made a lot of simplifying assumptions in my economic analysis, but no matter what assumptions you make, it is a dollar chasing a dime.  

The Governor’s real impetus for the Rule is climate change, which much to the dismay of many of my doubting associates, I get.  As a believer, I think we do need to start eating the elephant in the room, one small bite at a time.  But we need to focus on the highest producers who make enough dollars to afford it.  In addition, higher producers also have higher emissions, so you will get more bang for the buck. Marginal wells, on the other hand, need to be excluded from the rule.

Otherwise, if we take too big a bite of the elephant to start with, we are going to choke to death before we even get going.  

George Sharpe is an investment manager for Merrion Oil & Gas of Farmington.