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.

Deliverability, demand affect prices
With the Alliance Pipeline expected to begin shipping up to 1.325 bcf/d to Chicago and points beyond in fourth quarter 2000, "Canadian producers have a lot of gas to find in order to fill this incremental takeaway capacity," CIBC said.

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 US 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.

Similar US trends
Similar trends have been seen in the US gas industry. Year-to-year US production was flat at 51.3 bcf/d in 1999, but US output is expected to grow 1% in 2000 and 2001. Significant production growth has been limited by low activity levels, especially in the deepwater Gulf of Mexico, because of low oil prices in 1998 and 1999 and high initial decline rates of 35-40% on new wells.

US 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 US production.

US demand also is outpacing supply, with the US 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 US 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 (US)/Mcf , up from $2.15 the same time a year ago.

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