U.S. TAX CREDITS SPURRING COAL SEAM, TIGHT SANDS BOOM AMID CONTROVERSY

Oct. 14, 1991
A.D. Koen Gulf Coast News Editor Federal tax credits have sparked a boom in U.S. drilling for gas contained in coal seams and tight sands. Some analysts say drilling for unconventional nonassociated gas accounted for as much as one third of all U.S. gas wells drilled in 1990. Production of unconventional gas is leaping, and this source is providing the biggest share of net gas reserves growth in the U.S. With the recent expansion of federal tax credits beyond coal seam gas to include tight
A.D. Koen
Gulf Coast News Editor

Federal tax credits have sparked a boom in U.S. drilling for gas contained in coal seams and tight sands.

Some analysts say drilling for unconventional nonassociated gas accounted for as much as one third of all U.S. gas wells drilled in 1990.

Production of unconventional gas is leaping, and this source is providing the biggest share of net gas reserves growth in the U.S.

With the recent expansion of federal tax credits beyond coal seam gas to include tight sands gas, there is no sign of a letup in the unconventional gas boom.

That poses a dilemma for the U.S. gas industry. While some operating companies are scrambling to take advantage of a rare federal tax credit related to drilling, others complain the resulting production is contributing to the U.S. gas deliverability surplus. Proponents point to the value of establishing potentially vast U.S. gas resources for when they might be sorely needed in the future.

Tax credit opponents, however, complain there is no logic in what they see as currently subsidizing an otherwise uneconomic gas resource while companies are shutting in conventional gas production in a depressed market. Tax credit proponents also have leveled criticism at how the federal Section 29 tax credit, renewed in 1990, is being implemented.

Whatever the fate of unconventional gas development and related tax credits, it is clear that, for those companies involved in the action, it is one of the few bright spots in a largely moribund U.S. gas industry. That alone would auger well for coal seam and tight sands action to continue apace.

STATUS REPORT

U.S. coal seam gas activity in 1991 has shifted focus from drilling to completions, while tight sands drilling is on the rise.

In 1990, extension of the Section 29 tax credit spurred U.S. coal seam gas drilling to record levels. Operators this year are trying to catch up with 1990's frantic drilling pace.

After Congress extended the renewed Section 29 credit to tight sands gas wells spudded before yearend 1992, several companies responded by announcing large tight sands drilling programs.

In 1990, qualified coalbed methane production received 86-53/MMBTU from the Section 29 tax credit. The Section 29 credit for tight sands production this year is 52/MMBTU. The coal seam credit is adjusted annually for inflation, while the tight sands credit is not.

In Texas, qualified high cost gas production as defined in Section 107 of the Natural Gas Policy Act receives an abatement of the state's 7.5% severance tax. The exemption is allowed for gas produced between Sept. 1, 1991, and Aug. 31, 2001, from NGPA Section 107 wells drilled between May 24, 1989, and Sept. 1, 1996.

COAL SEAM FOCUS

While industry debates the effects of Section 29 tax credits, unconventional gas development continues apace.

Again this year, the Black Warrior basin of Alabama and Mississippi and the San Juan basin of Colorado and New Mexico are focal points of U.S. coal seam activity, Dwight's Energydata Inc., Richardson, Tex., reports.

According to Dwight's, during the first 7 months of 1991 operators in the top 15 U.S. coalbed methane basins:

  • Completed 992 wells, compared with 1,821 completions for all of 1990.

  • Filed 292 permits to drill new wells but canceled or abandoned 305 permits. In 1990, 4,514 permits to drill were filed and 406 canceled or abandoned.

A study by Ammonite Resources, New Canaan, Conn., found U.S. operators in nine basins last year drilled 3,600 coal seam wells in the rush to qualify for the Section 29 tax credit, more than half of all U.S. coal seam wells drilled to date (OGJ, May 20, p. 32).

Last year's drilling in coal seam areas far exceeded completions. At yearend 1990, Ammonite said, 40% of 3,587 coal seam wells were producing in Black Warrior basin and 49% of 1,926 wells in San Juan basin.

In Black Warrior basin, operators this year through July filed permits to complete 455 wells and 65 permits to drill new wells. Total 1990 Black Warrior filings included 581 completions and 1,565 drilling permits.

Through July 1991 in San Juan basin, operators filed for 380 completions and 100 drilling permits, compared with 857 and 1,795, respectively, in all of 1990.

According to Dwight's, 1991 San Juan permit abandonments and cancellations through July totaled 165, compared with 127 for all of 1990. Cancellations this year in Black Warrior basin reached 19 at the end of July and in 1990 totaled 141, Dwight's says.

Dwight's data on 1991 Appalachian basin coal seam filings through July indicated lower activity across the board: 37 drilling permits, 41 completions, and 41 cancellations/abandonments. Total 1990 Appalachian coal seam filings were 319 drilling permits, 260 completions, and 46 cancellations.

COAL SEAM HIGHLIGHTS

Several companies that in 1990 led U.S. coal seam drilling have sharply scaled back 1991 drilling plans in favor of completions.

Meridian Oil Inc. this year through July filed eight permits to drill wells in San Juan basin. In fourth quarter 1990, Meridian permitted 94 new locations in the basin. This year through July, Meridian concluded work under 128 drilling permits, most of them productive.

At yearend 1990, Meridian had amassed Fruitland coal seam reserves in San Juan of 1. 1 88 tcf by participating in 981 wells, 428 connected to gathering lines. For the year, Meridian completed 172 Fruitland wells. During first half 1991, Meridian produced about 200 MMcfd of coalbed methane.

Equitable Resources Inc.'s energy resources unit this year plans to drill 55 net coal seam wells in the central Appalachian basin of western Virginia. Last year, Equitable drilled 41 net coal seam wells on its 300,000 acre leasehold. Production there will be delivered into an existing gathering system without significant additional costs.

In southeastern Illinois, DI Energy Inc. has begun a small project in a shallow Pennsylvanian coal seam in Williams and Saline counties. The initial test of DI's 1-10 Penn Central well produced 278 Mcfd of gas from an abandoned coal mine at 246 ft. DI plans to drill 9 wells within the next 60 days at a cost of about $15,000 each, all to depths of 220-350 ft. DI by yearend 1992 could drill 30-40 wells on a 42,000 acre leasehold covering about 20 abandoned mines.

J.M. Huber Corp., Houston, has led San Juan basin action this year with 22 permits. Mitchell Energy Corp., The Woodlands, Tex., was credited with 10 filings.

Amoco Corp. last year completed its drilling program in Black Warrior basin and has filed permits to drill 15 San Juan coalbed wells, mostly in Ignacio-Blanco field. Amoco's San Juan drilling during 1992 could increase significantly. It has interests in 1,124 coal seam wells in San Juan and Black Warrior basins, 822 of which are company operated.

ARCO Oil & Gas Co. this year plans to drill one Ignacio Fruitland coal seam well and several more in 1992. It also plans one Ignacio Blanco well. At yearend 1990, ARCO had drilled 104 Fruitland wells in Colorado. The company plans no additional coal seam drilling this year in the eastern U.S.

In 1990, ARCO drilled 72 Black Warrior coal seam wells on its Maxwell's Crossing acreage in Robinson's Bend field of western Tuscaloosa County, Ala.

Devon Energy Corp., Oklahoma City, last year completed 102 upper Cretaceous Fruitland coal seam wells on its Northeast Blanco Unit (NEBU) in San Juan basin. In July Devon cut gross NEBU production to 65 MMcfd from 115 MMcfd because of low wellhead prices. Devon's coal seam production from northwestern New Mexico amounted to 6 bcf, two-thirds of Devon's total gas production.

Gas pipeline capacity out of San Juan basin should catch up with wellhead deliverability by spring 1992.

That's when El Paso Natural Gas Co. and Transwestern Pipeline Co. will complete two construction projects that will increase basin capacity by 1.3 bcfd (OGJ, Aug. 12, p. 42).

So much San Juan coal gas is shut in that Transwestern received nominations of more than 1 bcfd of gas for its 520 MMcfd line.

COALBED METHANE RESERVES

Energy Information Administration last month reported U.S. gas production from coal seam wells doubled in 1990.

Preliminary EIA data also show coal seam reserves added in 1990 accounted for 75% of U.S. net reserves growth, pacing the first annual increase in U.S. gas reserves since 1981.

In August 1991, the Potential Gas Committee estimated the U.S. coalbed methane resource base at 145.1 tcf as of Dec. 31, 1990, up 60% from yearend 1988 (OGJ, Aug. 5, p. 23).

Coal seam gas reserves at yearend 1990 stood at 5.087 tcf, 3% of all economically recoverable U.S. gas, EIA said.

EIA estimates unconventional gas production by 201 0 could increase to 4.35 tcf from 1.25 tcf in 1989. It noted coalbed methane reserves jumped by 1.411 tcf in 1990, with most of the increase in Alabama, Colorado, and New Mexico.

Ammonite predicted 12 tcf of coal seam gas reserves will be developed by 1993. At peak production during 199294, 9,050 coalbed methane wells will be producing 2-2.8 bcfd, 4-6% of total U.S. deliverability, Ammonite said.

At yearend 1990, Ammonite estimated coal seam production at 623.5 MMcfd.

Gas Research Institute estimates 90 tcf is recoverable of the U.S. 400-900 tcf coalbed methane resource base. GRI estimates about 183 tcf of U.S. coalbed methane resources are in Colorado, broken out by basin as Piceance 84, San Juan 50, greater Green River 34, and Raton 18.

GRI places the Appalachian basin's coalbed methane resource base at 61 tcf. Earlier this year, GRI let a $1 million contract to Dames & Moore, Los Angeles, to study problems associated with producing gas from the basin's coal seams.

TIGHT SANDS ACTION

Several large independents have announced drilling programs in qualified tight sands formations.

Enron Oil & Gas Co. plans to drill 300-400 tight sands wells in Texas and Wyoming by yearend 1992.

Coastal Corp. has begun a tight sands drilling program in Utah. Production is expected from that program by the 1991 heating season. Coastal also will drill tight sands wells in Texas and Virginia during 1991-92. The company expects to drill about 300 tights sands wells altogether in the three states.

Amoco this year could drill more than 200 tight sands development wells in company operated areas in Wyoming, Colorado, and Texas. Tight sands drilling activity in 1992 likely will decline, but plans haven't been finalized.

Arkla Exploration Co. is on schedule with a $90 million, 2 year plan to drill about 80 tight sands wells in the Cotton Valley and Travis Peak formations in Carthage and Waskom fields in East Texas by yearend 1992.

Pennzoil Co. expects this year to complete a 49 well East Texas program, begun last year, targeting Travis Peak in Carthage and Bethany fields.

Enserch Exploration plans to drill 15-25 tight sands wells during 1991-92 in Cotton Valley. Also, Enserch will drill tight sands wells in the Uinta basin of Wyoming and Utah.

By early September, Texas Railroad Commission during 1991 had approved 391 of 660 requests for tight sands well determinations. TRC received 361 of the requests after June 6.

By early October, Federal Energy Regulatory Commission had approved 18 of 32 requests this year to qualify new tight sands formations (see table). Sixteen of the 32 applications received during 1991 arrived in July and August, FERC said. FERC has delayed eight tight sands decisions because of challenges filed during 45 day comment periods following applications. Four comment periods will expire in October and November, and FERC has yet to act on two applications that expired just before the end of September.

TIGHT SANDS RESERVES

Estimates of tight sands reserves are thought to be significantly greater than that of coal seam reserves. But there is comparatively little reservoir information available on which to base estimates.

The National Petroleum Council is preparing to issue a new estimate of U.S. tight sands gas reserves.

According to unofficial, preliminary NPC data, the Cotton Valley and Travis Peak in East Texas could have as much as 31 tcf of tight sands gas in place. About 700-800 bcf of that total can be recovered with current well spacing, existing production technology, and a wellhead price of $1.50/Mcf, industry sources say. Improved technology could increase recovery to 3.9 tcf.

Other preliminary NPC data estimate 17.2 tcf of tight sands gas in San Juan formations Picture Cliffs, Chacra, Dakota, and Cliff House and Point Lookout members of Mesaverde. About 1.1 tcf of that gas would be recoverable at $1.50/Mcf and 3.2 tcf recoverable with the Section 29 credit.

In 1980, NPC estimated the tight sands resource potential outside proved fields in 12 U.S. basins at 444 tcf of gas. By comparison, NPC estimated tight gas in another 1 01 smaller basins at 480 tcf. Incremental additions to U.S. tight sands reserves by 2000 could reach 156 tcf with gas prices at $2.50/Mcf in constant 1979 dollars, 237 tcf at $5/Mcf, and 290 tcf at $9/Mcf, NPC said.

In 1987, the Department of Energy estimated tight sands production at 1.2 tcf of gas.

ICF Resources Inc. earlier this year said tight sands production had increased to about 1.7 tcf/year.

ICF estimates about 4 tcf of recoverable tight sands reserves will be added by the time the Section 29 tax credit expires at yearend 1992.

Combined data from ICF, GRI, NPC, and the University of Texas at Austin place U.S. tight sands resources at more than 622 tcf (see map). ICF is updating estimates of U.S. tight sands reserves under a contract from NPC.

At yearend 1989, the Department of Energy estimated Lower 48 tight sands reserves at about 180 tcf.

American Gas Association says other estimates of the Appalachian tight gas resource vary at 225-1,861 tcf. Included are middle Devonian shales and siltstones in Pennsylvania, New York, Ohio, Kentucky, West Virginia, and southwestern Virginia.

DOE placed tight reservoir and shale gas resources in the Appalachian basin at 211 tcf.

WORSENING THE SURPLUS?

Persistent surpluses and low prices on U.S. gas markets are causing a growing number of producers to question whether now is the time to subsidize unconventional gas supplies.

Because of low gas prices, some companies with large, unconventional gas drilling and development programs are shutting in gas production not qualified for federal subsidies. They contend production from Section 29 wells isn't the only or even the major cause of the persistent gas deliverability surplus.

The furor over pricing has prompted DOE to begin studying how the Section 29 credit has affected U.S. gas prices.

Proponents of the tax credit say it provides the economic incentive needed to:

  • Offset high development costs of unconventional gas.

  • Help assure adequate long term U.S. gas supplies.

  • Encourage more thorough assessment of unconventional gas reserves.

  • Speed development of new production technologies.

Criticism of Section 29 credit falls into two general groups.

Some critics say the tax credit skews drilling activity and gives unconventional gas a pricing edge that forces operators to shut in conventional supplies.

Others complain the tax credit can't be used to offset the Alternative Minimum Tax (AMT) or applied to tax liabilities in years after qualified reserves are produced. Independent operators are trying to convince federal lawmakers to allow Section 29 credits to be used to offset AMT liabilities. And support is building for a push in 1992 to renew the credit for unconventional wells spudded after Jan. 1, 1993.

EFFECTS ON MARKETS

So far, coalbed methane production has accounted for most supply gains resulting from Section 29 tax credits.

Producer opinion is split on whether enough unconventional gas is entering U.S. markets to affect prices.

Enserch Pres. Gary Junco says the Section 29 tax credit compounds market problems because companies have to produce unconventional gas to qualify for the credit.

"We've got a gas market that is oversupplied, and a credit designed to provide incentives for additional supply," Junco says. "That gas has to flow, and it is adding to the gas supply and driving down prices."

He says Enserch has seen situations where lower priced coal seam gas from the Rocky Mountains has displaced gas marketed in Texas.

"Producers can use the tax credit to cut the market by as much as 15/Mcf," Junco said.

Enron Oil & Gas Chairman Forrest W. Hoglund contends his company's ambitious tight sands development isn't contributing to U.S. gas surpluses.

"We're not adding to supply; we've shut in other production," Hoglund said.

He says lack of discipline among producers is the major cause of gas market surpluses.

"Some companies are trying to crowd gas into markets that won't hold it 10 months/year," Hoglund said. "They're willing to sell it to anybody, anywhere, at these prices, and rather than hold back, they just keep pushing it on the market."

Amoco official Ray Thompson said, "While you might argue today's market doesn't need more gas, who's to say what the market's going to look like in 5-10 years?"

About 6-8% of Amoco's U.S. 1991 gas production of 2.2 bcfd will come from wells qualifying for either coalbed methane or tight sands credits, most drilled before 1991, Thompson said. That percentage will increase as the coal seam reservoirs are dewatered and more wells are hooked up and as production declines in conventional gas reservoirs. Amoco's 1990 coalbed methane production in Black Warrior and San Juan basins averaged 74 MMcfd.

USING SECTION 29 CREDIT

Despite the potential revenue available through the Section 29 tax credit, not all companies can benefit from it because the credit can't be used to offset AMT liabilities.

Enron can use the credit this year for tight sands gas production. But Hoglund is critical of the limitation.

"A company with a net operating loss can't use it, and a lot of companies have been in that position since 1986," he said.

Junco said the only way for most independents to benefit immediately is to negotiate a long term deal with a third party who places a higher value on unconventional gas because he can use the credit.

"People making energy policy didn't have that in mind," Junco says.

"But that is the way Section 29 development is proceeding."

Section 29 credits could benefit Enserch in a few years but not right away.

"The question to me, really, is how the credit affects the industry overall," Junco says.

"Fundamentally, I think it artificially adds gas to an industry that's already oversupplied."

EFFECT ON DRILLING

Proponents of Section 29 tax credits say U.S. drilling activity-on a yearlong slide-would fall even farther were it not for work on coal seam and tight sands wells.

Companies with substantial tight sands drilling programs say many of the wells they are planning through 1992 wouldn't be drilled without the credit.

Six of eight rigs drilling for Arkla are working in tight sands areas in East Texas, including five in Carthage field. Arkla expects to have 40 tight sands wells drilled in East Texas by yearend, including 20 producing about half its 13 bcf/year gas output in the region. Many of the tight sands wells Amoco plans to drill this year and next are a direct result of the decision to extend Section 29 credits, Thompson said.

Hoglund estimates more than half the rigs drilling for Enron are working on tight sands wells, many of which would not have been drilled this year or next without the tax credit.

"With these really low gas prices, we can't afford to be active in too many other places, so we're focusing on the tight sand areas," Hoglund says.

By yearend 1991, Enron expects to drill 75 wells to Eocene Wilcox at 9,00010,000 ft in the Lobo trend of South Texas, 50-60 wells to Canyon sand at 5,000-6,000 ft in Sawyer Canyon field of West Texas, and more than 40 wells mostly to Upper Cretaceous Frontier strata at 8,000-9,000 ft in Wyoming's Big Piney field.

Enron expects during 1991 to add gas production of 150200 MMcfd from tight sands wells. That volume won't increase net company gas production because low prices have prompted Enron to shut in significant volumes of production, Hoglund says.

He estimates tight gas accounts for about 25% of Enron's total gas reserves.

Enserch's Junco says the credit will spur 1991-92 drilling in some areas, but merely skew it in others. In some cases, even the gas credit won't be enough to make deeper qualifying reserves competitive with shallower conventional reserves.

"in instances where it can be passed through to offset income from other subsidiaries, we will see Section 29 wells being drilled at the expense of conventional wells," Junco says.

But overall, he says, if the Section 29 credit "was going to be a big boom to the industry we would have seen a big jump in drilling activity by now.

CREDIT CHANGES

Federal tax credits for coalbed methane and tight sands gas production would be more useful to small operators if the law allowed producers to use the credits to offset AMT, industry officials contend.

Enron Corp. Vice-Pres. Richard D. Kinder says his company has been able to use the Section 29 tax credits "because our oil and gas subsidiary has a parent that has been profitable."

While agreeing with claims unconventional gas production is depressing prices in the short term, Kinder says the tax credit is a sensible way to assure long term supplies will be available on U.S. markets.

"We hope it will be renewed, but we've got to change tax law so we can use the Section 29 credit against AMT," Kinder says.

Mitchell Energy & Development is promoting legislation that would allow independent producers to apply Section 29 tax credits against AMT liabilities.

"It's very important," Chairman George P. Mitchell said. "Independents are paying enormous AMTS, but there's no way we can use the tax credit for coal seam or tight sands gas. We've got to get the law changed so independents can use the tax credit against the AMT."

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