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Canadian Drilling Declines Continue

Drilling will drop by 41% across western Canada this year to the lowest level since 1999 as low natural gas prices pinch exploration and development budgets, predict service and supply contractors.

The number of wells drilled across the region for all targets will tumble to 10,000 in 2009 from 16,940 last year, says a bleak revised forecast by the 270-company Petroleum Services Association of Canada (PSAC). Drilling exclusively for gas is projected to drop to 5,855 wells this year from 9,700 in 2008.

The anticipated slump continues a decline that has been under way at an accelerating rate since western Canadian drilling peaked at 24,750 wells in 2005, including 17,150 for gas. Activity dropped to 23,265 wells in 2006 (15,100 for gas) and 18,500 in 2007 (11,200 for gas).

The slide began when top Canadian production companies called a halt to acceleration of field activity that they blamed for "hyperinflation" of costs. Senior producers lopped about C$2 billion (US$1.7 billion) off their annual drilling budgets starting in late 2006. The feverish pace peaked after the 2005 hurricane season in the Gulf of Mexico swamped New Orleans, damaged offshore production and sent prices soaring in Canada as well as the United States.

Alberta royalty increases, which had nearly 90% popular support in political polls that swept away industry and financial community resistance, were also blamed for the 2007 and 2008 drilling declines. After winning re-election last year with an increased legislature majority, the province's Conservative government partially rescinded and postponed the royalty changes to counter the decline in gas activity. But no amount of government help has turned out to have the power to counter the 2009 slide by the North American market, PSAC President Roger Soucy said. "Even Alberta doesn't have enough money to compensate for the commodity price declines we've seen," Soucy told a gloomy PSAC forecast meeting last Thursday in Calgary.

The gas price is seen as still vulnerable. "I don't see it stopping declining for a while yet," said Calgary analyst Andrew Bradford, Canadian energy research director for Raymond James Ltd.

His projections call for gas to average US$3.75/Mcf for all of this year. Similar forecasts are spreading among Canadian energy economists and financial analysts, with some saying it is conceivable that the market bottom will be around $2.

By a Raymond James count, Canadian gas production has already dropped about 1 Bcf/d over the past year to slightly less than 15 Bcf/d. But the supply erosion is not yet enough to tighten the North American market and start putting a floor under prices.

"It's because of the shales -- it really is different this time," declares a Raymond James presentation slide. The market is headed for a glut because U.S. production is still on the rise from the recent wave of high-tech drilling, driven by previously strong prices, into formerly untapped formations led by the Barnett Shale in Texas, Bradford said. His calculations show U.S. production capacity nudging 65 Bcf/d this year, with onshore supplies of about 57 Bcf/d alone equal to the total of offshore plus onshore output since the mid-1990s.

His projections also show injections into U.S. storage facilities hitting their upper limit of 3.75 Tcf this fall, prompting shut-ins of excess productive capacity. A sharp drop in American drilling, comparable to the Canadian tailspin, will not likely cause an immediate supply decline because the first targets abandoned are the smallest gas reserves and the richest, most productive fields stay on the investment agenda the longest, Bradford said.

Raymond James sees the drop in Canadian and U.S. drilling making a difference next year, when reduced gas supplies and the beginnings of an economic recovery are liable to tighten markets. The investment house forecasts a 2010 average price of US$6/Mcf.

The trends are rated as likely to drive gas prices back toward the double-digit range eventually because supply is bound to lag behind demand.

"We're going to be back to starting all over again," said Soucy, a veteran of three decades of Canadian industry cycles.

He estimates the 2009 drilling slump already forced his association's member companies to cut 12,000 to 15,000 jobs, or about one-fifth of their total staff this year. Another estimated 9,000 layoffs have been done by member firms of the Canadian Association of Oilwell Drilling Contractors. If gas and oil industry unemployment persists for more than a few months the workers will drift off into other fields and the Canadian industry will face a repeat performance of its notorious, cost-inflating personnel shortages the next time the price cycle turns up, the PSAC president predicted.

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