Canadian gas supply strength could keep lid on gas price upturn

While the general outlook for the North American gas market has brightened this year, there is much debate over whether this improvement will be driven mainly by supply or demand. It's important to isolate the dominant driver because that gives us a sense of the scope of the gas upturn in 2002.

In 2001, the notion of "demand destruction" emerged as the dominant driver. A gas price spike from the year before in tandem with a sluggish economy had crushed demand growth, especially in an industrial sector that scrambled to switch to oil from gas and to reduce overall consumption. That trend was exacerbated by a mild winter, and the result was a gas price that slipped below $2/Mcf.

With the recent rebound in gas prices despite a continuing strong gas storage overhang, the focus has since shifted to expectations of "supply destruction." The collapse in gas prices has cut a swath through the count of drilling rigs targeting natural gas. Because so much of the 2001 surge in drilling and gas supply was opportunistically driven by the price spike, it follows that the reverse would be true. And now we have projections from many corners that a sharp, sudden drop in US wellhead deliverability will mean an overall slump in production of 1-2% in the second half. This was not a great concern for the market bears, who have been warily eyeing a record year-to-year storage surplus.

But what has surprised many observers was a late-winter cold snap that siphoned off much of that surplus just as the tally of gas-directed rigs continued to plummet. There is now a growing conviction that economic recovery, together with the 40% jump in oil prices this year, is spurring a rebound in gas demand. Combined with the already documented—and accelerating—supply destruction, that trend has sparked a revival in gas spot and futures prices of more than $1/Mcf in the past month. And $4/Mcf looms as the next threshold.

Or does it? There are those who contend that continuing growth in Canadian gas supply will keep a lid on the US gas price recovery.

Canadian gas outlook

Contributing to the outlook for a slide in Canadian gas supply in 2002 was a projection of capital spending falling 30% on the year, combined with a winter slump in Western Canadian rig utilization to 75% from the usual 90%.

But CIBC World Markets Inc. analysts Christopher Theal and Mark Bridges in March insisted that Canadian gas supply will remain flat this year at 16.6 bcfd, not decline.

They cite a surge in winter well completions—40% above prior-year levels in December and January—a shift to deeper drilling and its concomitant rise in increased well productivity, a decline in service costs of 20-30% from a year ago, and a significant new increment of supply from the Ladyfern area.

Beyond Western Canada, a growing influx of gas from Canada into the US Northeast is helping to smooth out the tradition of high prices and unreliable supply from the Gulf Coast and Midcontinent, notes Boston-based Energy Security Analysis Inc. Leading this surge is the increasingly prolific Sable Island area off eastern Canada.

The numbers increasingly bear out this thesis. After a slow start in January—caused largely by an outage on TransCanada PipeLines Ltd.'s Alberta system that shut in 100 MMcfd averaged out over the month—Western Canadian gas production in March climbed about 3% from the prior year. That will continue to rise with the addition of new pipeline capacity to Ladyfern, allowing a further increment of 250 MMcfd of production there, the CIBC analysts estimate. They also count on another 55 MMcfd from Sable Island, a 25 MMcfd/well rise in average wellhead deliverability, and a total of 7,050 gas completions in Western Canada in 2002 (vs. 11,177 in 2001).

If gas prices continue to stay closer to $4/Mcf than to $3/Mcf, the market can also count on a continuing rise in US LNG imports as well as another opportunistic uptick in US gas drilling, which also will help erode the supply destruction theory propping up gas prices this year.

On the other hand, if oil prices spike out of sight given current geopolitical uncertainties, any related boon to competing gas would soon be undermined by the resulting damage to a still-fragile economic recovery.

(Online Apr. 26, 2002; author's e-mail: [email protected])