While clinging to hope that a cold winter, economic recovery and drilling slumps will sop up the North American natural gas glut, Canadian suppliers remain braced for the long spell of lean prices to stretch well into 2010.

Preparations for the worst case scenario are showing in both the industry and Alberta, Canada’s main gas-producing province.

Talisman Energy Inc. announced a 15% staff reduction that cut 220 employees from the Calgary head office for its Canadian operations (see related story). The paring is part of a previously announced reorganization to shift focus onto shale gas development, which reduces the volume of drilling.

While horizontal shale drilling is more expensive than conventional activity, the new technique effectively cuts costs per unit of production by increasing the reserves tapped by each well.

The Alberta government, meanwhile, released a provincial budget update that forecasts Canadian gas prices will stay low enough to hold the annual average down to C$3.25 per gigajoule (US$3.24/MMBtu) for its fiscal year ending next March 31. The bleak pricing outlook translates into a 46% drop in projected 2009-2010 provincial gas royalties to C$1.9 billion.

The gas glut and resulting price slump have gutted Alberta gas royalties, which are the provincial treasury’s biggest single revenue source and which peaked at C$8.4 billion (US$8 billion) in 2005-2006. After almost a decade of running surpluses the provincial budget has been driven into the red by the gas plunge, with an unpredictable but certainly multibillion-dollar deficit prompting austerity measures in services such as education and health care.

Persistence of the gas glut into the heating season — temperatures have dropped into the minus 20 degrees Celsius range in Alberta — is prompting a mood swing among formerly optimistic industry analysts. “We are becoming a little more bearish,” Macquarie Capital Markets Canada research Chief Chris Felton told an investment symposium held last week in Calgary by the Small Explorers and Producers Association of Canada.

For now, Macquarie is standing by previous forecasts that gas will rebound to an annual average US$7.00/MMBtu for 2010. But the improvement increasingly looks like it will start later in the new year than previously expected, Felton said. “We’ve got lots of gas,” he added, pointing to storage facilities filled to the brim with inventories of 611 Bcf in Canada and 3.8 Tcf in the United States.

The onset of frosty weather in Western Canada has given gas prices a lift. Alberta trading hub prices have risen to a range of C$4.80-5.00 (US$4.56-4.75)/MMBtu. But the current cold snap spike remains only half as high as peaks hit when supply and demand are in better balance.

Current prices are just high enough to cover estimated costs of “half-cycle” supply development, or drilling new wells into established fields where no pipeline or other construction is needed. The breakeven price for in-fill supply development averages C$4.25 (US$4.04)/MMBtu across the Western Canadian Sedimentary Basin, the Calgary energy investment boutique of Peters & Co. calculates in a research note. The break-even point for “full-cycle” development, including new pipeline and processing facilities, is estimated to be C$5.55 (US$5.27)/MMBtu.

Enough Canadian producers have cut costs below the industry average, and are executing switches into shale gas, to ignite a modest drilling recovery.

As of last week, Calgary-based FirstEnergy Capital Corp. estimates the number of drilling rigs working across western Canada has grown to 377. That remains fewer than the 430 rigs that were active at the same time in 2008, but the new total is a big improvement on the virtual halt in activity hit by the Canadian industry in the spring and summer of this year.

“Our current bullish forecast has prices ramping up to the high C$5 (US$4.75)/Mcf range during first-quarter 2010, but this will be highly dependent on exports and the weather,” FirstEnergy said.

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