While convinced the oil price is a bubble ready to burst at any time, Canadians see a firm floor holding up under natural gas — and not least because it is a struggle to maintain their contribution to the North American “continental market.” Consensus forecasts north of the border draw a sharp contrast between the oil and gas markets.
The Calgary energy shares boutique of Peters & Co. is typical, with predictions underlining expectations for wild volatility on the oil side, but stability for gas. The firm’s current outlook calls for a 2004 oil average of US$38 per barrel or about 30% less than today’s spike and a 2005 average of $30.
The Canadian investment house expects gas to average US$6/MMBtu this year and continue to hold up at $5 in 2005. Little change is seen developing in the gas market’s leading indicators of drilling, deliverability and storage. The virtually unanimous verdict in the Canadian industry is that oil prices incorporate a “fear premium” inspired by speculation that somehow, somewhere, supplies will be disrupted by war in the Middle East or instability in Russia or political and labor conflict in Nigeria, Venezuela or even Norway.
The president of the country’s top oil and gas producer, EnCana Corp.’s Gwyn Morgan, estimates the fear premium at up to $10 per barrel. Like most of his peers on the Canadian supply side of the energy markets, Morgan flat out refuses even to try predicting oil prices, saying no one can.
Others suspect the fear premium could be much greater. One rule-of-thumb in use for making the premium estimate is to compare oil and gas prices. Natural gas is viewed as a good benchmark for a current “real” value of energy, based on supply and demand, because production and consumption are in reasonable balance. The difference from oil is solely that there are no threats of war or terrorism disrupting gas as a commodity primarily traded via safe pipelines in North America.
The energy content of a barrel of oil equals about six MMBtu of gas. As of Aug. 20, gas was $5.51 per MMBtu and oil towered at $48.70 per barrel. If the two commodities were in sync, oil would be $33.06, which makes today’s premium $15 or about 30%. Constraints on Canadian gas deliverability — about 15% of U.S. supplies and one-fourth of total North American production — are natural effects of real limits to the resource endowment, according to a long-range review by another Calgary specialist in energy investment, FirstEnergy Capital Corp.
Western Canadian gas fields, led by Alberta with about 80% of reserves and production, show increasingly clear signs of having reached their limits and of starting to slip into old age. While there are always exceptions in the form of new discoveries by companies venturing out to difficult drilling regions, overall the trends are clear. Since 1990, FirstEnergy’s latest calculations show the average annual decline rate of western Canadian well productivity has tripled to 21% from 7%.
At the same time, the initial production rate from new wells in the region has fallen by about two-thirds to about 310 MMBtu/d from 860 MMBtu/d since the early 1990s. “On the sheer arithmetic of initial production rates alone, that would suggest twice as many wells have to be drilled as before just to keep overall (Canadian) natural gas production flat,” observes FirstEnergy, which tracks field performance closely as a leading indicator of commodity and share prices. “However, combine this with the increase in decline rates . . . it’s no wonder why overall gas well drilling has increased more than four-fold since 1996.”
Western Canadian producers drilled 3,722 wells in 1996. In 2003, they drilled 14,898 wells to sustain production, with only marginal growth in total output. FirstEnergy predicts the western Canadian gas well totals will approach 16,000 this year and again in 2005. The investment house predicts average annual production gains of only 500 MMcf/d in 2004 and 200 MMcf/d in 2005, based on current overall initial production and decline rates. All the drilling activity is resulting in changes of less than 3% to total western Canadian productive capacity of about 19 Bcf/d. Among FirstEnergy’s conclusions: “Growiing natural gas production in western Canada is going to remain a very serious challenge for the producing community, and “natural gas pricing prospects remain strong.”
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