Black Diamond Energy Inc. is shutting in nearly 300 coal-bed methane wells in the Powder River Basin, according to the company's president, Eric Koval.

S&T Bancorp of Pennsylvania, which received $109 million in federal bailout money, recently called in the operator's debt of some $30 million.

With the price of natural gas down 35 percent since December to about $3 per thousand cubic feet, it doesn't pay to keep the wells in production, according to Koval. He said his employee roster of 43 has been cut in half during the past year.

"I have guys crying - tears in their eyes - showing up in my office pleading for work," Koval said. "It feels like we've been regulated out of business. It's not one particular thing. It's the Chinese torture of death by a thousand cuts."

Another coal-bed methane operator, Storm Cat Energy USA, is under bankruptcy protection but says it continues to operate some 400 wells in the basin and expects to come out of bankruptcy by the end of the year.

While larger operators with bigger budgets say they're temporarily shutting in production to ride out the low commodity price, several small independents say they can't survive without cash flow. The situation has prompted state and federal regulators to increase reclamation bonding requirements, further adding to the financial plight of these small companies.

"The problem we have is it doesn't look any better on the horizon. It doesn't look like it's going to get any easier," Koval said. "For smaller independents, the regulation is too difficult to overcome at this point."

However, some say the escalation of regulatory requirements is not entirely to blame for the industry's woes.

Critics say the industry was given a pass early on when coal-bed methane first emerged as a commercial enterprise in the basin. In the late 1990s, the industry was allowed to dump production water on the surface with minimal management requirements. Federal officials in 2003 opened public lands to 50,000 wells with only an "adaptive management" approach to protecting sage grouse.

"The industry is just being asked to pay the costs that society has borne for them either through the government or private landowners," said Steve Adami, board member of the landowner group Powder River Basin Resource Council.

Monitoring and scientific studies have since proved more environmental mitigation was necessary all along. Critics say the industry was given a false indication that capital costs would remain low, and only now are operators being forced to pay the true cost of business, which includes more environmental protections.

"The bigger problem is just a sluggish economy and reduced demand for natural gas," Adami said. "That's a bigger problem than any regulation."

Cost and regulation

The costs of environmental management and permitting have gone up every year for several years.

Koval said permitting expenses - including wildlife surveys, cultural artifact surveys and a long list of other requirements - can add up to about $30,000 per well. It can take up to two years for federal regulators to approve a plan of development, which delays return on investment.

One key permitting cost increase came in 2007 when the George W. Bush administration tacked on a $4,000 processing fee for each well on federal minerals.

Bureau of Land Management officials note that the natural gas boom in the Rocky Mountain region forced the agency to more than double its staff at some field offices. In fact, for several years the BLM Buffalo field office was under a mandate to process permits for a minimum of 3,000 coal-bed methane wells annually.

Buffalo field office assistant manager Paul Beels estimates the actual cost of federal analysis and permitting averages more than $5,000 per well. The coal-bed methane industry currently holds 2,065 active permits, according to BLM officials. The industry has allowed some 112 permits to expire so far this fiscal year.

Regulatory requirements and expenses have risen at the state level, too. Last year, the Wyoming Oil and Gas Conservation Commission increased its bonding requirement from $3 per foot of well depth to $10 per foot. Koval said that shrinks the amount of credit available to a small producer, if he can get any additional credit at all.

Further adding to the coal-bed methane industry's troubles is the fact that it used to enjoy a yearlong drilling season. But drilling is now squeezed into seven months because the industry has drilled out most private and state leases and is now beholden to more stringent federal stipulations regarding sage grouse and nesting raptors.

Water management remains an overriding concern in the industry.

Large volumes of water are pumped from coal seams in order to produce the methane. The industry pumps about 600 million barrels of water from coal aquifers in the Powder River Basin each year, according to the state. Some of the water is used in irrigation and to water livestock, but a majority of the water is not put to a specific beneficial use.

Koval said that early on in the play, the Wyoming Department of Environmental Quality allowed his company to discharge production water on the surface. Then the agency stipulated no on-channel discharges and eventually required expensive groundwater monitoring.

Steve Degenfelder, senior vice president of exploration for Casper-based Double Eagle Petroleum, said the increasing cost of regulation went relatively unnoticed because of strong natural gas prices during the recent boom.

"When the price of these commodities goes down, the permitting costs do not," Degenfelder said. "Over the boom period we let a system perpetuate itself, and that's going to be more of a burden when prices are low."

Degenfelder explained that the rising cost of permitting is difficult to pass on because oil and natural gas are commodity markets.

"Producers eat it," Degenfelder said.

Risks and reclamation

Koval said he regrets not liquidating assets two years ago when it seemed things couldn't get worse.

"The rules keep changing," Koval said. "Literally, the ground moved under our feet, and it continues to do so."

The PRBRC and other groups critical of the industry counter that, if anything, regulators have been too lenient toward coal-bed methane operators.

One key piece of evidence is a 2005 report by the Western Organization of Resource Councils that suggested some 84 percent of oil and gas facilities in the BLM's Buffalo field office area were found to be out of compliance with reclamation rules.

Beels said that since the report, his office has increased site inspections by 2,000 annually. The office issued some 447 written orders for non-compliance in 2005, and now the office issues about 200 annually.

"We feel that our compliance rate has gone up," Beels said.

Members of the Powder River Basin Resource Council have expressed concern that some coal-bed methane operators might not be able to meet their reclamation obligations because of financial duress.

In a May 12 letter to BLM Buffalo Field Manager Duane Spencer, the group suggested that the cost of interim and final reclamation on leases held by a number of small operators far exceed money put up by the companies under the BLM's "blanket bond" requirement.

Mike Worden, supervisor of petroleum engineering at the BLM Buffalo field office, said he is reviewing the bonds and facilities of several companies to ensure they have adequate bonding. The BLM may require individual companies to provide bonding well above minimum requirements if the agency deems it necessary.

If a company cannot meet the BLM's bonding requirement, the agency can take legal action to revoke its federal leases.

"That hasn't happened yet," Worden said.

A particular concern would be a company under financial duress that only holds coal-bed methane wells in a depleted field. Worden noted that the only depleted areas in the basin are where coal seams are relatively shallow and the cost of plugging wells is inexpensive.

He said, in general, the operators who control depleted coal-bed methane fields are also developing new fields, so they have a stake in meeting interim reclamation requirements.

"The majority of stuff we have going on is still very active, so they've got a long life ahead of them," Worden said.

Contact energy reporter Dustin Bleizeffer at 307-577-6069 or {M7dustin.bleizeffer@trib.com. Read his energy blog at tribtown.trib.com/DustinBleizeffer/blog.

BY THE NUMBERS

*As of September 2008, a total of 29,719 coal-bed methane gas wells had been drilled in the Powder River Basin.

*As of summer 2008, the industry had produced a cumulative 2.9 trillion cubic feet of gas - about 11.6 percent of the estimated 25 trillion cubic feet of proven coal-bed methane reserves in the basin.

*The industry drilled an average 300 wells each month in 2008. The industry drilled one well in May this year, and no wells were drilled in June.

www.trib.com for a video report on coal-bed methane well reclamation inspections.]]->