Canadian Gas Drilling Rebounds but Production Lags

Canada’s drilling activity for natural gas is enjoying record levels, but that hasn’t translated into production growth in the western provinces. A concentration on shallow gas and fields that deplete quickly has led to flat production. Over the next year, increasing demand may boost gas prices.

These are some conclusions drawn by CIBC World Markets Equity Research in a recent study.

Flat production trends for gas, coupled with the industry’s focus on rapid production declines and shallow gas drilling in the Western Canadian Sedimentary Basin (WCSB), recently prompted analysts at CIBC to raise their gas price forecasts for 2000 and 2001 to $3.25 (Can.)/Mcf from $2.85/Mcf.

In a report on North American natural gas markets, CIBC said that gas drilling has tended toward shallow gas wells the past 3 years in the eastern region of the WCSB, where first-year decline rates on new wells are 30-50%. Over the past 5 years, about 50% of the gas wells drilled in Western Canada were in the shallow regions of eastern Alberta and western Saskatchewan, and fewer than 10% have been drilled in the deep Foothills belt.

Focusing on shallow wells allowed producers to tie in wells in a short period of time, mitigating the effects of declining oil cash flows during the 1998-99 oil price slump. This helped producers with shallow gas inventories, but with low deliverability of 250 MMcfd/well, it did little to add to gross field deliverability in Western Canada. As a result, field receipts in Alberta, which account for 85% of total Western Canada deliverability, have remained flat at an average 12.3 bcf/d over the past 3 years.

Producers will have to shift towards deeper wells with higher productivity in order to meet supply growth projections from the WCSB. Until that happens, Alberta prices should remain very strong as supplies remain tight, relative to the takeaway capacity situation of pipelines such as Alliance and projects such as Northern Border Pipeline and TransCanada PipeLine Ltd.’s expansion.

When Northern Border and TransCanada came online in late 1998, takeaway capacity increased 1.1 bcf/d. That increase has also caused the basis differential between Alberta and the U.S. Midwest to narrow to below transportation costs, thus boosting Alberta prices, which are 50% higher than a year ago and double prices seen in 1998.

CIBC said it anticipates record gas prices for 2000 because of new demand from gas-fired electric power plants, which EIA projects to rise this year by at least 340 bcf or about 1 bcf/d. Other factors such as the more than 8,000 Mw of nuclear capacity that is currently down, and the 12,500 Mw of capacity set to go off-line this spring as plants switch gears for refueling or maintenance, should bolster gas prices. High fuel oil prices, plus high air conditioning loads induced by the extreme heat that is forecast this summer, will also put upward pressure on prices.

But aside from a few high-impact plays such as Fort Liard and the Foothills belt, high-impact drilling in Western Canada has been limited despite the current positive price environment. On average, well depths have declined by 10%/year the past 3 years. With first quarter 2000 drilling activity not showing any signs of a shift toward higher-impact activity in the face of healthy commodity prices, "We do not foresee a material increase in field receipts in 2000", CIBC said.

Flat production and strong demand growth point to a limited ability to refill storage this injection season, while the outlook for end-of-winter 2001 storage levels suggest 5-year lows. CIBC also pointed out in its report that storage levels remain on the low side, compared with previous years, despite a third consecutive warm winter.

U.S. gas production since 1987 has grown 1%/year, on average, and has been essentially flat since 1994 at 51-52 bcf/d. Drilling activity was up in 1997 and 1998 but made little impact in adding to U.S. production.

U.S. demand also is outpacing supply, with the U.S. Energy Information Agency projecting demand growth of 3.5% in 2000, 4.1% in 2001, and 1.8%/year through 2010. Incremental demand has been met through gas imports from Canada, where "healthy" withdrawals from Canadian storage were used to meet demand.

Despite the lack of new production and low storage levels, the bullish outlook for gas prices hasn’t affected the share prices of gas-weighted producers, particularly those with high exposure to Alberta spot prices, CIBC said. The combination of robust U.S. demand growth and lagging supply has moved Henry Hub spot prices for gas to new highs for this time of year. At the time the report was released, gas was trading at $3.06 (U.S.)/Mcf , up from $2.15 the same time a year ago.

by Michael Vickerman, RENEW Wisconsin

Petroleum and Natural Gas Watch, Vol. 1, Number 2. December 30, 2000

Even though the following discussion paper was intended for a Wisconsin audience, I am posting it here because some might find it relevant to the ongoing discussion of electric utility deregulation, which was premised on cheap, abundant supplies of natural gas as a generation fuel. In sizing up the California situation, we should not forget that in 1995, the cost of marginal power (from a gas-fired plant) was less than the embedded cost of system power in California. Small wonder, then, that major industrial and institutional customers wanted to peel off from the utilities and negotiate their power contracts with independent suppliers.

In just 4 ½ years, the situation has reversed itself: marginal power costs are soaring and regional supplies of native cheap power (Pacific Northwest hydro) are now overextended. Gas-fired plants are riding to the rescue but they will be the most expensive generators on the system. And because they are owned by independents and not utilities, the latter is now leading the charge for a return to re-regulation. What a stunning reversal of fortune that would be, out there in the very cradle of electric utility deregulation. It should be remembered that the one area of the state that didn’t deregulate—Los Angeles—has been virtually untouched by the unraveling of the state’s power system.

The reality of runaway natural gas prices will reveal itself to Wisconsin ratepayers when they open up their January utility bills. A commodity that cost a little over $2/MMBtu in December 1999 now fetches over $9/MMBtu in the wholesale market, a quadrupling in price in just 12 months. Couple that phenomenal price increase with colder-than-average temperatures this December and it’s a safe bet that next month’s heating bill will double that of January 2000.

These prices are bound to have a chilling effect on the regional economy. But the situation could be worse. In fact, in the relative warmth of California, it is worse. There, spot market prices for natural gas pierced the $50/MMBtu mark this month. In a state where natural gas accounts for nearly one-third of the electricity produced, a combination of low stocks and dry weather in the Pacific Northwest have sent wholesale power prices skyward and utility stock prices tumbling. Earlier this month, lobbyists for the state’s largest utilities scurried back to Sacramento to plead for a return to good old-fashioned rate regulation. If the Governor and the Legislature grant the utilities’ petitions for relief, the majority of California’s electricity customers will see an immediate 25% increase in their electric rates.

Meanwhile, the pronounced lull which gripped the natural gas industry in 1998 and 1999 has now given way to frantic activity. The North American gas-directed rig count is up 25% over 1997 levels. Desperate for new hires, drillers are offering salary packages not seen in the industry since the go-go years of the early 1980’s. Some observers believe that this burst of energy may lift next year’s domestic natural gas extraction levels above the 19 trillion cubic feet mark, a level not seen since the early 1980’s. But will that increase be enough to cover the widening gap between domestic consumption and extraction? Very unlikely in the near-term. Can we count on imports from Canada and Mexico to make up this difference? Not if demand keeps climbing.

According to The Dismal Scientist, 70% of the new homes built in the United States are heated with natural gas. As a result, natural gas now heats 52% of the nation’s housing stock. The pressure on natural gas supplies will build further as new homes continue to pop up across the landscape.

Not only is natural gas now the primary energy source for home heating but also the fuel of choice for new power plants. Proposals for building new gas-fired generators—as much as 250,000 MW nationwide according to one estimate—have been coming in fast and thick to keep pace with rising demand. This new round of power plant construction is expected to boost annual demand for natural gas by several trillion cubic feet over the next five years. With this acceleration of demand hard-wired into our economic future, the whole natural gas supply infrastructure—rigs, crews, pipelines and storage capacity—has to be beefed up if a rough equilibrium is to be maintained.

Matthew Simmons, head of a Houston-based energy investment banking firm, is not sanguine about the growing imbalance in the supply-demand equation. In a recent speech at a U.S. Department of Energy gathering, Simmons issued this warning:

"If summer weather is hot, particularly in the eastern third of the U.S., we could see gas storage withdrawals occurring in the summer months. If this does not happen this coming summer, it will almost certainly occur a year later. And once gas withdrawals begin in the summer, the U.S. has one winter left before we have run our storage system dry. Once this occurs, we will be forced to relegate natural gas to a seasonal use".

Here in Wisconsin, nary a week goes by without a utility or an independent company announcing plans to build a gas-fired power plant during the next decade. At last count, some 6,000 megawatts’ worth of new gas-fired generating capacity have been proposed, and some of these plants are now moving through the permitting pipeline. If approved and built, these plants would expand current installed capacity in the Badger State by 50%. If you are wondering what sort of risks are posed by relying so heavily on natural gas given existing supply constraints, California is a good place to begin your research.

Prudent investors respond to uncertainties by diversifying their portfolios and hedging their bets. In the current energy environment, a heightened emphasis on conserving energy and developing renewable power sources would serve to reduce customer exposure to wild gyrations in natural gas prices. Let us do what we can in Wisconsin to minimize wasteful energy consumption and expand the contribution of our native energy sources before we strap ourselves into the natural gas thrill ride that has left Californians distinctly unamused.

"Outlook for Natural Gas: Is a Train Wreck Pending?" Simmons & Company International, U.S. Department of Energy’s Strategic Initiatives Workshop, Queenstown, Maryland, December 6-9, 2000. Web address: www.simmonsco-intl.com/research/default.asp

"Powerless in California", by Thorsten Fischer. The Dismal Scientist, December 18, 2000. Web address: www.dismal.com

"California’s Gas Pains Are Hardly Natural", by Allan Brady. The Dismal Scientist, December 13, 2000. Web address: www.dismal.com

"Natural Gas Is No Refuge From Oil", by Allan Brady. The Dismal Scientist, November 21, 2000. Web address: www.dismal.com

"You Say You Want a Revolution", by Peter Asmus. Green@Work, Nov.-Dec. 2000. Web address: www.greenatworkmag.com

Petroleum and Natural Gas Watch is a RENEW Wisconsin initiative that tracks the supply-demand balance of these fuels, highlighting the economic and energy security issues raised by supply constraints. For more information on the global and national petroleum and natural gas supply picture, visit "The End of Cheap Oil" section in RENEW Wisconsin’s web site: www.renewwisconsin.org

On this issue read "Power Generation: Dependent on Natural Gas" by David A. Purcell, June 7, 2000. You will find it on the Simmons & Company International website, www.simmonsco-intl.com under the heading Research. He explains concretely how independent non-regulated generators with simple gas fired turbines can exploit both markets in electricity and natural gas to siphon off revenue from these markets.