Field contractors are braced for a long and deep slump in Canadian natural gas drilling, blaming a perfect storm of glutted markets, unfavorable currency exchange rates and Alberta's overhaul of government royalties.

The resulting squeeze on supplies will be worsened by rising consumption at Alberta oilsands projects that will continue to proliferate because the provincial royalty overhaul treated them gently, industry analysts indicate.

The Canadian Association of Oilwell Drilling Contractors and Petroleum Services Association of Canada are both predicting sharp declines in field activity next year. The groups' forecasts are widely accepted. They have a history of reliability and draw on member companies that experience industry trends early and first-hand.

CAODC predicts western Canadian well completions will drop to 13,735 in 2008 or 16% fewer than a projected 16,393 this year and down 38% from 22,298 in 2006. About four-fifths of the activity is in Alberta, where gas is the target for three-quarters of drilling. CAODC also said a timing quirk has worsened the effects of Alberta's royalty changes, which as of 2009 raise the top rate on prolific gas wells to 50% from 35% and end a vintage formula that kept collections lower on newer wells.

The province about cut in half increases proposed by a royalty inquiry report and made special allowances for low-productivity and deep wells (see NGI, Oct. 29). But CAODC said producers have postponed projects that can only be done in annual winter rushes, when marshy northern ground freezes solid enough to support industry equipment. The drillers said delays in project decisions were caused by an intense, six-week political debate over royalties that included startling polls showing a majority of Albertans favor extracting greater revenue from industry.

PSAC's numbers are slightly different because its well data is gathered on a different basis known as "rig-released," meaning when drilling stops regardless of whether the bore finds enough gas to make it worth completing for production. But the message is the same -- "dramatic declines" are in store, says the voice of industry supply and service companies.

PSAC's latest forecast calls for 14,500 western Canadian wells next year, down sharply from an expected final tally of 17,550 for 2007.

PSAC expects activity to drop by 25% in Alberta next year, or more than enough to offset an anticipated 10% increase in British Columbia as producers follow through on successes in relatively deep drilling. Alberta relies heavily on shallow and coalbed methane drilling, which are most sensitive to changes in gas prices and costs because they are spread thickly over relatively small production volumes.

Average use of the western Canadian drilling rig fleet will fall to "a sub-economic condition," CAODC added. In the 1990s, years when more than 10,000 wells were drilled were considered healthy ones. But there were fewer than 500 rigs available to work. Subsequent years of gas price increases and rising demand for services prompted the fleet to grow to nearly 900 rigs, leaving the contractor sector less able to withstand lulls.

PSAC forecasts a Canadian average gas price of $6.25/Mcf next year. CAODC is only slightly more optimistic, predicting $6.50/Mcf.

The price forecasts reflect fear that the Canadian dollar will stay near parity with its United States counterpart. That spells a severe weakening of commodity prices seen by Canadian producers. In the 1990s every dollar gained by gas on the international market's U.S. currency yardstick spelled increases of up to $1.40 in Canada.

The Canadian foreign exchange advantage has evaporated, leaving producers, contractors and financial analysts insisting that prices must make a sustained recovery to at least US$8/Mcf to US$9/Mcf to rekindle the bygone Alberta gas drilling boom.

Results of the flat prices that set in a year ago, plus the exchange rate trends, are already showing on gas markets, CAODC suggests. The association estimates that over the past year, western Canadian production capacity has slipped by 1 Bcf/d, or 6%, to 15 Bcf from 16 Bcf. At the same time, proposed federal tax changes and continuing Alberta royalty incentives for oilsands projects will continue to fuel Canada's biggest industrial growth customer for gas, FirstEnergy Capital predicted.

A fall "economic statement" or mini-budget by the Conservative government in Ottawa pledged phased reductions in the federal corporate tax rate to 15% as of 2012 from the current 22%. The commitment came on the heels of Alberta Premier Ed Stelmach's announcement that oilsands royalties will all continue to be collected on after-costs plant revenues, rejecting an inquiry recommendation to add an off-the-top flat rate.

"What is old is new again, and project economics are back where they were before all this turmoil hit the market," FirstEnergy told clients in a research note. Alberta is also staying the least-taxed jurisdiction in Canada. The special status has long been thanks to royalties that have for generations enabled the province to refrain from raising corporate and personal taxes or collecting any sales tax at all.

Oilsands gas consumption is projected to triple over the next few years into the 2 Bcf/year range as output rises to at least three million b/d from slightly more than one million. Industry analysts see potential for the oilsands to approach five million b/d within 20 years.

The oilsands thermal extraction and processing operations use gas at a rate of 1 Mcf or sometimes more per barrel of production. Low or flat gas prices encourage projects by holding down production costs.

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