When it comes to royalties, less is more as far as producers are concerned. But a proposed restructuring of Alberta's royalty scheme announced earlier this month might not be enough to stem rapid gas production declines in the province, analysts at Barclays Capital warned recently.

"The [royalty] review [see NGI, March 15] was undertaken in response to the drastic pullback in oil and gas activity in the province following the introduction of the current royalty regime in January 2009," the analysts said. The royalty plan will not be finalized until May 31, they noted, and is expected to take effect in January 2011. "Golden days for Canadian drilling could indeed be within reach starting later this year. However, the royalty revision may not benefit natural gas sufficiently to reverse rapid production declines."

Unlike in the United States, they said, production in Canada pulled back sharply last year due to a "drastic contraction in drilling," with the average number of wells drilled down by 40% from the previous year.

"Alberta bore the brunt of the declines, while British Columbia increased production marginally, supported by the development of unconventional shale resources," the Barclays team said. "Canadian natural gas production is dominated by Alberta's large conventional resources, which accounted for 95% of the province's output in 2007. Alberta, in turn, was responsible for nearly 80% of Canada's natural gas production."

Coalbed methane contributes the remaining portion of Alberta's output. There are shale resources -- anywhere from 86 Tcf to 1,000 Tcf -- but development of these is a few years away, they said.

"...Alberta's gas comes at a substantial cost and is notably more expensive than the majority of newly developed resources in the U.S.," the analysts said. "In 2009 costs fell as the industry scaled back drilling (and demand for services fell), yet the breakeven price for new gas development, even with the upcoming royalty relief, likely remains well above the C$6 level."

The prompt month on the New York Mercantile Exchange (Nymex) is trading at about C$4.25/gigajoule, "a far cry from the price needed to break even for Alberta's conventional gas," they said.

Completions of gas wells in Alberta declined 59% year over year, an even steeper decline than that experienced by rig counts last year. This indicates that oil drilling was already favored over natural gas, the analysts said.

"Although the royalty revision may not be sufficient to trigger a broad-based revival of drilling for conventional Alberta gas, it could provide an adequate incentive to develop gas reserves with a high liquids content," according to Barclays.

The analysts noted that AECO basis tightened in 2009 relative to 2008, averaging minus US 65 cents/MMBtu. "We believe AECO basis should tighten further in 2010 as production continues to fall, albeit at a slower pace," they said, noting that AECO basis should average minus US 50 cents this year.

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