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Canadian Output Said on Steady Decline

Deteriorating Canadian natural gas supplies will do their gloomy bit toward drying up the North American gas glut for at least another year, a member of the National Energy Board (NEB) predicted last Wednesday.

NEB projections show that after falling by 17% since peaking at 16.5 Bcf/d in 2005 into the current 14 Bcf/d range, Canadian output will continue dwindling due to a prolonged 60% drop in drilling, NEB Commissioner Lyne Mercier said. The supply erosion will continue even if bullish forecasts of a price recovery come true, she told an annual Calgary conference of the Canadian Society for Unconventional Gas.

"We expect that the lack of drilling activity in western Canada in 2009, which is expected to continue into 2010, will cause production to drop in all [price forecast] cases until late 2010 at the earliest," Mercier said. "Much of this production decline is momentum, with current low activity being felt down the line." The NEB expects the supply erosion to continue even if prices rebound, saying a recovery will take time to rekindle drilling programs and accelerate the annual western Canadian well count much beyond the 18-year low of about 8,000 currently forecast for 2009 and 2010 by industry field contractor associations.

"Of note is that only in the high case [gas prices at US$7/MMBtu in 2011] do we expect production even to flatten in the near term," Mercier said. "And our low case [$4 in 2011] has Canadian production falling to just over 12 Bcf/d by the end of 2011. Even the medium case [$5.50 in 2011] sees production falling to just over 13 Bcf/d by the end of 2011."

The NEB's expectations take into account projected acceleration of shale gas development in northeastern British Columbia, where Canadian trend setters such as EnCana Corp., Nexen Inc., Devon Canada and TransCanada Corp. have affirmed that they are going ahead on multiple supply and pipeline projects. The fledgling transplant of U.S. technology is rated as too young to make up for the slump in conventional fields.

"While drilling activity in tight gas and shale gas steadily increases their shares of Canadian production, it is not enough to offset conventional declines until 2011 and then production is expected to rise only slowly afterwards," Mercier said.

The Canadian export share of the United States gas market -- historically about 15%, but dropping since early 2008 -- is liable to fall faster than production. At the same time as Alberta gas consumption by thermal oilsands extraction projects continues to climb, U.S. pipeline development is heading Canadian exports off at the U.S. border, the NEB member observed. She pointed to the record 84 projects that installed more than 4,000 miles of new pipe in the United States last year, plus the growing ability of marketers serving central Canada and the northeastern states to tap into increasing, competitive U.S. supplies.

"The availability of Rockies gas for import into Canada near the Dawn Hub at the southwestern tip of Ontario has important implications for Canadian pipelines that serve the eastern Canadian market," Mercier said. The Dawn trading center is poised for expansion under an application currently before the NEB.

"From 1.9 Bcf/d to 3.4 Bcf/d flows into the southwestern tip of Ontario, depending on the season." Most of the deliveries still arrive from western Canada, but U.S. supplies represent "a significant and growing portion." Some of the U.S.-sourced flows through Dawn are re-exported to northeastern states, but "growing U.S. supplies may be able to displace eastbound western Canadian gas in the future. More implications arise from growth of Marcellus Shale production in the northeastern United States, LNG [liquefied natural gas] imports and potential Utica Shale production in Quebec and New York State," Mercier said.

Barclays Capital appeared to agree with the NEB assessment. Analysts with the financial firm said last week that the Horn River and Montney shale plays in British Columbia -- like their counterparts in the Lower 48 -- have a productive future, but their bright outlook is overshadowed by steep declines in conventional Canadian production due to maturing fields and substantial cutbacks in drilling.

"The majority of Alberta's gas comes from conventional fields that are well into their mature years and require significant new well additions to offset declines from existing production," the Barclays analysts wrote in a research note. "Drilling in Alberta started to lag the level needed to generate production growth in 2007, and output has fallen by a cumulative 1.7 Bcf/d since 2006. This year Alberta's production averaged 0.7 Bcf/d lower than during 2008 for the period January through August."

But the Montney and Horn River plays are the bright spots in Canada's gas industry as production declines are widespread in Canada. "Unconventional gas has large potential in Canada, with the Horn River alone possibly exceeding 1.7 Bcf/d of production at its peak...However, this growth is a long-term target and would take years to achieve."

So for now Alberta's production declines tell the story for Canada overall as gains and losses in other provinces roughly offset each other, according to the Barclays team.

The good news for producers is that production declines are strengthening AECO basis relative to Henry Hub. The Barclays team said AECO basis risk is skewed to the upside with AECO prices strengthening relative to Henry Hub. "We expect AECO basis to average minus US70 cents/MMBtu in 2009 and minus US50 cents in 2010," they wrote. This compares with an AECO differential to Henry Hub during 2008 of minus US$1.48/MMBtu, they noted.

"Despite the expected strengthening of Canadian basis relative to the U.S., any rebound of drilling activity in Canada is likely to lag that of the U.S. in 2010," the analysts wrote. "Our forecast for Henry Hub prices to average $5.05/MMBtu in 2010 does not provide for sufficiently strong prices to rekindle development of Canada's vast conventional reserves."

The Barclays team isn't the first to note the impact of low commodity prices and dramatic drilling declines on Canada's natural gas outlook. The Petroleum Services Association of Canada earlier this month released a forecast that only about 8,000 wells will be drilled in 2010. The outlook calls for a repetition this year, with severely depressed activity across Western Canada stagnating at one-third of the record 24,666-well level set in 2005 (see NGI, Nov. 16).

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