Analysts: Rising Canadian Output Foreshadows Falling Prices

Rising production in Canada -- pushed by the Ladyfern discovery in Western Canada -- could exacerbate a "temporary" natural gas oversupply situation in the United States, which in turn could lead to falling North American natural gas prices, lower earnings and declining cash flow estimates for 2002, according to Lehman Brothers analysts Thomas Driscoll and Phil Skolnick in a research note released last Thursday. This gas surge, said the analysts, could send gas prices falling to the $2.25-2.50/MMBtu range for a "sustained period of time" -- meaning months, not weeks.

However, Raymond James analysts don't believe the Canadian supply will have as big an effect. In a research note last week, Raymond James wrote that it believes Canada's natural gas export capacity is "not likely" to be an issue in U.S. storage levels despite record levels of drilling, and it will have only a "minimal effect" on overall supply and demand. In last Monday's Stat of the Week, an analyst with Raymond James wrote that Canada has contributed less than 1 Bcf/d in the first half of 2001 to U.S. supplies, and even with the "significant" Ladyfern discovery in British Columbia, the figure is only expected to rise another 0.5 Bcf/d in the second half of the year.

By year's end, the Lehman analysts expect U.S. production to be up 1.5-2.0 Bcf/d -- in the 3-4% range. However, Canadian production was up about 9%, or 1.3 Bcf/d in July compared to a year ago, which includes an estimated 0.1 Bcf/d from Eastern Canada. The wild card will be "future production gains at Ladyfern," which they said "could yield an overall production increase in Canada" of more than 1.5 Bcf/d by the end of the year.

The Ladyfern gas discovery alone contributed nearly 40% of the July increase, they noted. "Current announced expansion plans by Murphy/Apache and Canadian Natural Gas Resources at Ladyfern could add an additional 230 MMcf/d of natural gas into the market by December. In addition, we believe Alberta Energy Co.(AEC) is likely to add to its Ladyfern production." Using pro-forma June 2001 results for the announced plans to add 230 MMcf/d, year-over-year production increases would total 1.4 Bcf/d, or 11%.

In April, AEC increased its 2001 gas sales forecast by an average of 75 MMcf/d for the entire year. AEC said its daily production from Ladyfern would average 100-150 MMcf/d during the last half of 2001 (see NGI, April 23). Ladyfern was only put in play late last year, but so far, producers there have recorded outstanding results (see NGI, June 18, Feb. 26).

Another factor is Eastern Canadian production, which rose 130 MMcf/d to 505 MMcf/d in June, said the analysts -- and the July numbers have not been released.

"Assuming the majority of the Canadian production increase is destined for the U.S. market, [it] would lead us to conclude that supply available to U.S. consumers will show a year-over-year increase of 3.0-3.5%+ Bcf/d by year end," said the analysts. "This is a 5-6% increase in overall supply (U.S. demand in round numbers averages about 60 Bcf/d). In addition to this increase in supply, we could be looking at 600-800 Bcf overhang in inventory by year end."

The Lehman analysts said they "continue to use a $4/MMBtu long-term natural gas price," but believe that "intermediate-term natural gas price performance will disappoint investors and lead to a difficult environment for exploration and production stocks."

Raymond James noted, however, that it continues "to believe that the rapid build up in U.S. storage volumes is related more to demand-side issues, such as declining industrial demand and fuel switching, rather than growth in North American supply." The research note follows news by the American Gas Association, which reported a 3 Bcf net injection into U.S. storage facilities two weeks ago, an unprecedentedly low figure, then reversed itself this week.

A Raymond James survey of the reported quarterly data production volumes of Canada's top 13 natural gas producers found that Canadian production rose 11% in the first quarter and another 9% in the second quarter, adding about 2 Bcf/d of new production. A survey of the intra-Alberta pipeline system confirmed the analyst's results for the first quarter.

In the second quarter of 2001, Canadian storage filled at a rate of 2.3 Bcf/d compared with 1.3 Bcf/d in the same period a year ago. U.S. imports showed an increase of 0.9 Bcf/d between January and April 2001 compared to a year ago and "very likely held flat" in the second quarter at about 1 Bcf/d. "The only wildcard here is Canadian consumption"...but "if we conservatively assume that domestic consumption of natural gas in Canada remained approximately flat, then we come to a maximum overall increase in Canadian production of approximately 2 Bcf/d."

Raymond James did note that the hot Ladyfern prospect could boost imports into the United States, adding "another 250-300 MMcf/d of incremental import supply" through the rest of this year. However, "evidence shows that record levels of drilling in Canada have generated a small supply response of approximately 2 Bcf/d. However, even after adjusting for the incremental supply from the Ladyfern discovery, Canadian imports, excluding Sable Island, were probably only up approximately 0.8 Bcf/d during the second quarter and should show a 1.0-1.1 Bcf/d year-over-year increase through the remainder of 2001."

Based on evidence from several of Canada's major export pipelines, the Raymond James analysts noted "there is approximately 2 Bcf/d of unused capacity in the system right now. While the Westcoast and Foothills pipelines are probably running full right now, additional compression and underutilized space on both the TransCanada and Alliance Pipelines could provide another 1.7 Bcf/d of export capability, with a 300 MMcf/d expansion of the PGT line, bringing the total to approximately 2 Bcf/d by mid-2002."

Raymond James also noted that it is "highly unlikely that Canadian production can continue to grow at a rapid enough pace to fill an additional 2 Bcf/d of export capacity...and "in fact, depending on the ultimate size of the Ladyfern reservoir, it may be difficult to replace the production once the field begins its natural decline, causing available export capacity to actually increase."

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