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The Mood Is Dour in Canada's Gas Patch

Canadian natural gas field contractors are braced for their second straight lean year while the industry defers drilling until supply gluts burn off and the Alberta government retools development policies.

After reviewing intentions of their customer producers, the 270-member company Petroleum Services Association of Canada (PSAC) released a forecast Thursday that only about 8,000 wells will be drilled in 2010. The bleak outlook calls for a repetition of this year, with severely depressed activity across western Canada stagnating at one-third of the record 24,666-well level set in 2005.

The drop in total forecast 2010 drilling understates the deep erosion anticipated on the gas side of the Canadian industry, added the PSAC forecast. For the first time in memory, a 52% majority of new wells next year is expected to be aimed at oil.

Four years ago gas was the target for nearly three-quarters of the record drilling activity or 17,150 wells. When the numbers are all in for 2009, the gas well count is expected to come in at 3,815. In 2010 gas drilling is expected to slump even further to 3,210 wells -- a plunge of 81% since 2005.

"The dramatic drop in commodity prices is the main culprit for the decline," PSAC president Roger Soucy said. After virtually all forecasters turned out to be far too optimistic about gas this year, the contractor association refuses to believe bullish predictions of a gas rebound to an annual average in the range of US$6-8/MMBtu for 2010, which are currently circulating among Canadian financial analysts.

For 2010, PSAC expects gas to average C$5/MMBtu (US$4.70). "My glass is half empty," said Soucy, a veteran of 28 years of roller-coaster cycles as president of the association. "The numbers are brutal."

PSAC surveys of its member companies, which include all the large contractors and about four-fifths of the estimated total operations of all sizes in its industry segment, point to a severe human toll of the slump that is affecting the ability of the Canadian gas supply community to respond if the North American market tightens up. Job cuts have run so deep and long among the former 60,000 employees of PSAC member firms that there is little capacity left to increase field activity if prices rebound and producers put out calls to accelerate field activity, Soucy said.

The Canadian industry's health is expected to deteriorate more before it gets better. "We're drilling one-third as many wells as before," said PSAC Chairman David Yager, CEO of health, safety and environmental services contractor HSE Integrated Ltd. "We're tooled up to drill 20,000 wells. When we don't do that the competition among us is intense. We're going to see bankruptcies and consolidation."

Former PSAC chairman Al Huehn, president of Topco Oilsite Products Ltd., added, "I've been in this business for 30 years and we've never had to face the challenges we've had this time. Everybody's suffering from this industry downturn."

The slump is worst in Alberta, source of about four-fifths of Canadian gas production. In 2010, PSAC predicts the total Alberta well count will drop by 5% to 5,095. Field activity in British Columbia is expected to grow by 7% to 630 wells, with a high proportion of the work concentrated on deep and elaborate drilling into big shale gas targets.

The PSAC leaders said they hope a "competitiveness review" currently under way in Alberta will prompt the provincial government to undo damage done by a politically popular 2007 inquiry into royalties that led to increases in rates as of this year. Temporary reductions, prompted by slumping gas prices, have offset the royalty hikes for two years, but the hikes will automatically go back into effect unless the government makes permanent changes.

Unlike the royalty inquiry, the competitiveness review does not involve high-profile public hearings, participation is restricted to private meetings with producer and investment community leaders, and the study panel includes senior industry and finance figures. Soucy predicted the new review will at least obtain correct factual information on the state of the industry and requirements for a revival, but he added that only time will tell whether favorable policy decisions will eventually emerge from the provincial cabinet. The review panel has set a target of late this year or early 2010 for crafting a report and recommendations, but the government has made no promises about the timing of any resulting actions.

While the drilling slump and policy debates drag on, Canadian gas production capacity continues to deteriorate, led by a steep drop in Alberta output. As of October the Canadian Association of Petroleum Producers, citing records kept by FirstEnergy Capital Corp., estimates Alberta production has slipped to about 10.5 Bcf/d -- a 25% drop from 14 Bcf/d in fall 2005.

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