Natural gas and oil prices are on separate paths and liable to keep on diverging for the foreseeable future, according to Canada’s National Energy Board (NEB).
Gas takes the low road while oil goes high in a revision of the NEB’s supply and demand outlook through 2020, crafted in consultation with industry. Changes on both sides of the energy market since the last report in mid-2007 altered traditional economic relationships, in the board’s new view.
On the demand side, the NEB says events broke a former fundamental link between the two commodities, the ability of industrial and power generation plants to switch quickly between fuel oil and gas in response to price movements.
“Over the years the amount of this dual fuel-capable capacity has eroded to relatively insignificant levels,” the new forecast says. The change is “due to several factors including high maintenance costs, environmental restrictions and siting issues, raising the possibility that the observed relationship was becoming more of a behavioral artifact than a physical reality.”
On the supply side, surging development of tight and shale gas sources is reversing the mentality of scarcity that used to drive gas market spikes, most notably following hurricanes that damaged conventional production sites in the Gulf of Mexico in 2005. The emerging new supply of unconventional gas is so big that it “has the potential to expand the traditional discount that North American natural gas prices have received relative to world oil prices,” the NEB says. “The relative abundance of tight gas and shale gas could impact liquefied natural gas imports, frontier projects and exports from Canada to the United States.”
During the early years of energy market deregulation and free trade in the 1980s there were expectations that gas would achieve parity with oil. If energy equivalence determined prices, 6 MMBtu of gas would be worth the same as one barrel of oil, the NEB points out. Parity has not come to be. Geopolitical issues and anxieties that fire up markets for oil — but not gas — at first widened the value gap to 10 MMBtu per barrel, and have lately left no discernible relationship between the two commodities, the board says.
In its reference case or forecast of the most likely future, the NEB plots “an independent course” for gas. Its annual average price is projected to take until 2011 to recover to US$6.70/MMBtu, then rise by baby steps to US$7.50 in 2020. Oil surges ahead to US$90/bbl by 2020, or enough to buy 13 MMBtu of gas — more than double what the price relationship would be if energy equivalence determined the value of the two commodities (The NEB’s projections are in current dollars, with no attempt made to predict inflation’s effects on future nominal prices).
A new pattern could be emerging that ties gas to coal, the NEB observes. “Since mid-2007, natural gas prices have often tracked US$3.00 to $4.00/MMBtu below the residual fuel oil price, and closer to a delivered coal price to eastern power utilities including allowances for emissions permits. Such behavior has given rise to speculation that the lower boundary for natural gas prices has become the coal price, or effectively a ‘coal floor,'” the board says.
“The rationale for this view is the scale of the coal-fired generation fleet in the U.S., which is large enough that even a minor displacement of coal units through the dispatching of natural gas-fired plants to keep natural gas prices from falling further,” the NEB reports. The board points to U.S. Energy Information Administration data showing that American power plants burn about one billion tons of coal per year, which is the energy equivalent of a colossal 31 Tcf of gas, or 85 Bcf/d. Combined total U.S. and Canadian gas production is 70 Bcf/d.
The diverging market values mean Alberta thermal oilsands production will continue to grow and trim the availability of Canadian gas on the international market. While lowering expectations for the development pace in the northern bitumen belt, the NEB still forecasts that the use of gas by extraction processes will about double to 1.4 Bcf/d by 2020.
“As a result of the severe slowdown in conventional gas drilling activity and only gradual increase in unconventional drilling, Canadian production is projected to decline significantly over the 2008-2010 period,” the NEB says. “At the same time Canadian natural gas demand is likely to grow as use for oilsands production and power generation (by cogen plants at bitumen projects) continues to increase. This combination of declining production and rising Canadian gas requirements results in a lower net surplus available for export.”
By 2016, the NEB’s projections show Canadian gas exports to the U.S. falling to about 5 Bcf/d, or about half the peaks hit in 2001 and 2006. If the stalled Mackenzie Gas Project is revived and is built within the next decade, Canadian pipeline deliveries to the U.S. will recover to 6 Bcf/d, the board estimates.
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