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40% Drop in Drilling Expected to Send Canadian Prices Soaring

40% Drop in Drilling Expected to Send Canadian Prices Soaring

The Canadian natural-gas community sees potentially sharp price increases developing on its horizon, thanks to a happy coincidence of pipeline expansions and economic conditions on the supply side. As the Alliance Pipeline accepted its final certificate for its U.S. leg from the Federal Energy Regulatory Commission, rising prices were being predicted by prominent fixtures ranging from Peters &amp Co., an investment boutique specializing in energy stocks, to the dean of Canadian geological and engineering consulting houses, Sproule Associates.

The projections hold that price increases will start long before Alliance's scheduled in-service date, which remains postponed a year until Nov. 1, 2000, due to regulatory conflicts last winter and spring before the National Energy Board. Canadian approval is expected soon, following the recent completion of the environmental side of the Alliance case north of the border.

The price scenario, which is rapidly becoming a consensus forecast in Canada, rests on two observations. One, gas pipeline capacity will start increasing this fall, when expansions of the TransCanada and Foothills-Northern Border systems will add about 1.2 Bcf/d to Canadian export capacity into the United States. And two, the added pull on production capacity comes at a time when producers are too weakened by soft oil prices to accelerate gas drilling enough for a recurrence any time soon of the standard Canadian event so far in the 1990s - rapid increases in deliverability to surplus levels again.

The Sproule organization, which provides the supply-side supporting testimony for TransCanada expansion applications, expects a thorough grilling when the NEB opens hearings next month on a proposal for adding TransCanada facilities in 1999. Regulators, and shippers concerned over the potential toll effect of overbuilding the pipeline grid, are expected to probe the outlook for Canadian productive capacity much more thoroughly than usual.

The emerging questions are not whether Canada has the resource endowment to keep up with the pipeline grid or even whether today's gas prices make raising production economic. The answer to both those questions remains a resounding yes, from authorities including the Alberta Energy and Utilities Board. The problem is whether a production industry that focused heavily on oil for the past two years, when its prices were high and gas pipeline capacity was limited, now has the money to switch commodities.

The Peters investment house, which has a forecasting track record widely accepted as one of Canada's best, portrays gas producers as scrambling to keep up. Virtually all back pipeline additions. But most, except for a handful of almost pure gas producers such as Canadian 88 Energy, face "constrained" drilling budgets due to poor oil prices. In a new review of the state of field work, Peters says that so far this year, "natural gas drilling in Canada has failed to materially increase deliverability."

The securities firm predicts that after slipping nearly 30%, the oil price will average US$14.50 per barrel this year and stay soft at $15 in 1999, generating "a profoundly negative impact on industry cash flow." As a result, total western Canadian drilling activity could slip by nearly 40% to 10,300 well completions this year and erode further in 1999 to 9,000 completions.

Gas completions are weakened along with oil in this scenario. Aggressive programs of expensive deep drilling continue in the prolific Rocky Mountain foothills of Alberta and northeastern British Columbia among strong producers such as Amoco Canada. But those are in the minority. Overall, the Peters firm observes that "cost-sensitive producers are electing to consider natural gas developments judiciously close to existing infrastructure, and in many cases opting for well recompletions instead of new wells." In the longer term, "natural gas fundamentals for the Canadian basin are strong" and guaranteed eventually to generate accelerating field development. But "in the interim, producers will maximize the use of existing facilities, often pushing equipment specifications, and opt for rental compression in lieu of large one-time capital outlays involved in facilities expansion."

Gordon Jaremko, Calgary

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