Higher costs and a sustained drop in natural gas prices appear likely to continue into 2008, forcing some of the largest producers in Western Canada to cut their capital budgets and leading more of the smaller gas-heavy independents to sell assets or consolidate, energy executives said at a conference in Toronto.

Canadian Natural Resources Ltd. (CNR), Talisman Energy Inc., Husky Energy Inc. and Canadian subsidiaries of Devon Energy Corp. and Apache Corp. are preparing their budgets for 2008, and it appears that for the time being, next year's spending levels will be flat compared with 2007 or even cut back. Only EnCana Corp. indicated it may grow its spending by a small amount in 2008.

"If prices stay where they are, we will remain pretty conservative," Husky COO Robert Peabody said at the Peters & Co. North American Oil & Gas Conference last week. Husky is spending about C$1 billion this year on Western Canadian gas projects. "If anything," he said, spending "likely will edge down as we move it to other parts of the portfolio where we think we can get a bigger bang for our buck."

Gas well drilling in the Western Canadian Sedimentary Basin (WCSB) has dropped by about a third from a year ago, sending Canadian gas production down by 500 MMcf/d or more, according to government officials. Earlier this month outgoing CEO Jim Buckee of Canada's third-largest gas producer, Talisman, said his company is slashing its North American spending in 2008 to C$1.5 billion from the C$2.2 billion planned this year.

Chris Seasons, president of Devon Canada, said service costs have dropped, but not enough to justify higher spending. Gas prices need to be US$8-9/Mcf on the New York Mercantile Exchange to generate an after-tax rate of return in Western Canada, he said. Devon cut its spending on its gas projects in Canada by 15% this year to C$1-1.2 billion. The company likely will keep spending at around C$1 billion next year.

"When we look at the opportunities, there are more compelling places to invest than in Canada right now," said Seasons.

Apache's Canadian operations reduced the drilling program in the WCSB by half this year to 400 wells, and it cut spending to C$800 million from C$1.2 billion in 2006. Spending won't be increased going into 2008 -- at least not now, said John Crum, president of Apache Canada.

"Next year, we would say that gas prices are going to stay in this US$5 range, and so you will probably see a similar number of wells" in 2008 as in 2007, Crum told the Peters attendees.

"It's difficult to pull money away from oil right now," said CNR Vice Chairman John Langille. Gas exploration costs "are still too high in comparison to the sales price," and 2008 spending will probably be about the same level as this year. "Costs are too high relative to the price of natural gas...Where everything is today, it's difficult to move that much higher."

About C$1.1 billion was budgeted for CNR's WCSB gas projects this year, which was about half of what the company spent in 2006. In 2008, the spending is expected to drop again to about C$1 billion. Langille said CNR plans to spend more money on its Horizon oilsands project.

EnCana's Michael Graham, president of the Canadian Foothills Division, said his company is slightly bullish about gas prices in the coming months. The Calgary-based producer is "tracking at the high end" of its production projections and cash flow for 2007. EnCana has about 27 million net acres in Canada and the United States. The Calgary producer has budgeted US$6 billion for North American spending this year and a slight increase is expected next year.

"Fundamentally, we still think North America is supply short...It's tough to find gas and it's tough to replace it," Graham said. "We're going to generate a tremendous amount of free cash flow again this year, in the order of about US$2.1 billion." EnCana also expects to have more free cash flow in 2008, which it now is using to buy back stock and pay dividends.

"We recently doubled our dividend to US80 cents per share," he said. "There's no reason to believe that our dividends won't continue to increase. We talk about this a lot with the senior executives and the board."

Graham said EnCana is not in the market for corporate acquisitions, but it is looking for bolt-on acquisitions from smaller oil firms that are adjacent to EnCana's major operational areas. The junior oil and gas producers in Canada are "suffering," he said, and Canadian gas production "is coming off a lot this year, maybe 5%-plus," which has to be replaced.

The acquisition market "is probably getting more attractive as some players are reaching a position where they have to consider their options," said Husky's Peabody. "But asset values are still quite healthy at the moment...it's not a fire sale yet."

Apache's Crum said "there are too many players here [and] it's not healthy. We're fighting over good employees, fighting over good land." That would not be the case if gas prices were higher, he added. However, Crum said Apache Canada does not budget for acquisitions. It is open to possible acquisitions, "but we don't know when they're going to come along."

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