Coal Bed Methane Pain

Out in the Rockies, natural gas isn't worth a whole lot of money today. The ability to transport gas out of the region via pipeline, also known as takeaway capacity, is extremely constrained. Production volumes have risen steadily, and local demand simply isn't there. This explains the yawning gap between national benchmark Henry Hub gas and Rockies gas.

In a little-reported event on Monday, a fire at a Wyoming compressor station led Cheyenne gas to trade for less than $0.05 per thousand cubic feet (mcf). Compared to the mid-$6 range for Henry Hub, that's free gas, for all intents and purposes. Without those key pipelines, however, customers have no choice but to pass on this gas.

Clearly, it's not a great time to be a Rockies producer. I can't imagine people are tripping over themselves to pick up the developed fields that Anadarko Petroleum (NYSE: APC) just put on the block. Still, Rockies gas outfits like Bill Barrett (NYSE: BBG) have held up surprisingly well in recent months. That may be because investors are willing to wait around for Kinder Morgan's (NYSE: KMP) Rockies Express pipeline to come online in a few months' time.

The true pain has been reserved for the coal bed methane (CBM) players. The simple economics are bad enough -- after $1/mcf of transport costs, these operators aren't clearing much on their gas sales. Add to that various geological and regulatory issues, and you're looking at some real basket cases.

Pinnacle Gas Resources has been in freefall ever since its May IPO was priced well below its initial offering range. A spinoff of Carrizo Oil & Gas (Nasdaq: CRZO), Pinnacle has been forced to slash its proven reserve figures, and Montana authorities have also prevented it from drilling.

Unfortunately, neither of these serious setbacks is limited to Pinnacle. GeoMet (NYSE: GMET) is facing geological challenges at its Gurnee field in Alabama, which contains nearly 60% of the firm's proved reserves. This company may also be forced to restate reserve figures, unless it can figure out how to increase gas flows from those wells.

One of the interesting things about CBM wells is that their gas flow rates actually increase as pressure drops in the coal seam. That's the opposite of a traditional natural gas well, which displays a high initial production rate that drops off with declining pressure. Unfortunately, flows at Gurnee wells have been flat for several quarters now. If these are in fact peak flows, then either the estimated gas in place will be recovered over a longer time period, or the estimate was wrong.

GeoMet isn't even a Rockies-focused CBM player, but it still faces serious pipeline issues. The company is tied up in a nasty tussle with larger CBM player CNX Gas (NYSE: CXG). A right-of-way dispute centering on a 32-acre tract of land is threatening the takeaway capacity of GeoMet's Pond Creek field. While proved reserves are lower here than at Gurnee, Pond Creek accounts for a larger slice of GeoMet's production.

I don't mean to pick on GeoMet. The most serious issue faced by all of the CBM players is water. These wells' pressure drops over time because water gets pumped out of the coal seam. But this isn't Evian we're talking about; it's high enough in sodium and metals to wither plant life with as much as a sideways glance. And there are billions of barrels of it.

Environmental concerns are holding up a tremendous amount of potential coal bed methane development. Fully 93% of the Powder River Basin in Wyoming and Montana is presently closed to CBM drilling. There are competing solutions to this wastewater issue, ranging from ion exchange treatment to reinjection to hydrogen generation. It's a tremendous opportunity, given the acute need for fresh water out West. Whichever company can unlock this water's utility has the potential to reap bigger gains than even the most skilled coal bed methane operator.