Natural gas drilling in Canada may be poised for an upturn later this year as oilfield service costs stabilize, but increased gas drilling may not be enough to compensate for the slowdown that began last year, energy executives said Wednesday.

Late last year in Western Canada, higher service costs led several producers to cut back planned conventional gas drilling projects (see Daily GPI, Nov. 2, 2006; Oct. 26, 2006). The cutbacks were followed by an exceptionally snowy winter in northern British Columbia and Alberta, which contributed to a further pullback in late-season drilling (see Daily GPI, April 13). Natural gas represents about 75% of all drilling in the Western Canada Sedimentary Basin (WCSB), and activity levels are dictated by natural gas prices and customer cash flows. In 3Q2006 the spot price of natural gas decreased sharply, and the negative sentiment carried into early 2007.

However, some of the majors and independents said Wednesday they are beginning to see signs of better days ahead in the Canadian oilpatch.

"Service costs in Canada have come down a lot" compared with a year ago, ConocoPhillips CEO Jim Mulva told investors on a conference call to discuss quarterly earnings. ConocoPhillips slashed its Canadian drilling program for 2007 after costs escalated last year. "What we have seen resulted in some pretty significant reductions in our upstream business in Canada." However, "we are seeing reductions in terms of costs on the drilling side. There is some indication of a moderation in inflation in terms of service industry costs in the Lower 48, but not quite to the same extent in Canada."

If costs continue to moderate, Mulva said it will be factored into ConocoPhillips' Canadian drilling plans next winter, when gas drilling ramps up once again.

"Compared to the initial thoughts of spending in Canada...we're looking at seasonality as we prepare for 2008, and what we see is a sustained level of lower service costs" said Mulva. "We knew we were always going to come back," and even though the cuts were made for 2007, he said the company has maintained its options to ramp up drilling when the time was right.

"We are beginning to see lower pressure on costs, and we see a better gas price environment," Mulva said. "We're working through plans right now [and expect to see] a sustained level of spending going forward into the winter season of 2008. We haven't determined that yet, but we expect to spend more money in 2008."

EnCana Corp., the largest gas producer in Canada, also has seen a shift downward in service costs, which should positively impact Canadian gas volumes. Even though EnCana cut back on its Canadian drilling projects late last year, the company still produced 3.4 Bcf/d from its North American operations in 1Q2007, which was slightly ahead of budget and in line with its guidance.

"Inflationary pressures are beginning to ease," said EnCana CFO Brian Ferguson. He said costs stabilized through 1Q2007 and "we are continuing to see an easing of inflationary pressures on drilling in Canadian [gas drilling] operations." In the Rockies, the "pace" of cost increases has been reduced, he added.

"The oilsands is an exception," Ferguson said of service costs. "There is a high level of activity, and that is maintaining pressure on costs." EnCana and ConocoPhillips are in a joint oilsands venture in Canada.

EnCana CEO Randy Eresman said that as many of the integrated producers reined in their gas drilling last year on higher costs, oilsands ventures were the beneficiaries of more money and more focus.

"I think the drop-off in Canadian gas production and the even bigger drop in Canadian [gas] exports is related to capital spending reductions in Canada that are largely related to oilsands growth and the demands for gas there," said Eresman. "We still believe there are tremendous opportunities in the [WCSB] deep basin of Canada...Mostly at this point, it [the decline in gas] reflects a lack of activity, and a 25% average rig rate drop...A lot of money is going into oilsands, and that has created a reduction in drilling."

For instance, EnCana's Greater Sierra gas operations reported an 11% drop in volumes in 1Q2007 from 1Q2006. EnCana drilled 28 wells in the first three months of 2007 versus 85 a year earlier.

Calgary-based Precision Drilling said Wednesday that 1Q2007 marked the lowest drilling rig operating days in the first three months of a year for the company since 1999 and the fewest service rig operating hours since 2002.

However, "supply and demand fundamentals for North American natural gas are beginning to show cause for industry optimism," Precision said. "Natural gas storage levels in North America are approximately 10% lower than the prior year and commodity prices have shown recent strengthening. There are indications the lower drilling levels in Canada since last June are beginning to affect Canadian gas supply as field receipts are reportedly lower than the prior year. Depletion rates for new and existing wells in combination with the recent moderation of drilling levels in the United States are expected to lower natural gas supply growth and, in due course, rejuvenate natural gas prices and land drilling activity in Canada."

The first three months of 2007 appear "to have set the stage for lower year-over-year activity levels during the next two quarters," Precision said. "Cold weather in late March and heavy snowfalls in northern areas are expected to delay the spring thaw and lengthen road ban periods. As a result, in combination with significantly lower customer demand, activity in the second quarter has quickly curtailed."

Precision noted that the reduced level in drilling rig demand in March already has resulted in pricing pressures.

"It is expected that rates will become even more competitive after road bans are lifted," Precision said of Canadian drilling.

Baker Hughes CEO Chad C. Deaton said Wednesday the company's profits in North America were up 3% in 1Q2007 "despite a weaker-than-expected rig count in Canada." Deaton noted that North America's colder-than-normal temperatures late in the season resulted in high gas storage levels, and while U.S. gas-directed drilling "appears to be sufficient to satisfy modest growth in natural gas demand in the short term," it "may be insufficient to offset decreases in imports from Canada and the decline in the productivity of reservoirs being developed over the longer term."

Baker Hughes' rig additions in North America "have been tempered to more closely match our expectations for slower near-term growth," Deaton said. "We will continue to monitor the North America market closely and will make additional adjustments, if necessary, while exercising care not to sacrifice our ability to respond to increased activity levels in the future."

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