The year 2012 was another bad one for Canadian natural gas producers as huge shale gas supplies and a stalled U.S. economy curbing demand growth combined to continue depressing prices far below historical norms.
Natural gas drilling continued its steep decline with around 2,500 wells drilled in western Canada. Production has been shut in across North America in response to the persistent low prices.
The question going into 2013 is: When will natural gas prices recover?
And the answer is that it depends on whom you talk to.
Canadian natural gas giant Encana Corporation believes gas prices will rebound somewhat in 2013, company president and chief executive officer Randy Eresman told shareholders at Encana’s third-quarter conference call.
In early 2012, Encana shut in about 500 million cubic feet per day of production in response to low prices. Eresman said the decision to cut production was made after gas prices dropped below US$2.50 per million British thermal units. Thecompany brought that gas back on stream in August.
With the forward curve reaching about $4 for 2013, “we thought it prudent to bring those volumes back on,” he said.
Eresman said Encana sees a number of sources for optimism going into the winter heating season.
On the demand side, he said gas use is growing in the power sector as it replaces coal.
“Relative to 2008 levels, we estimate that approximately eight billion cubic feet per day of natural gas demand has been gained from coal-to-gas displacement,”he said.
Eresman said this has contributed significantly to reducing the North American storage surplus from about 927 billion cubic feet at the end of the winter to about 250 billion cubic feet going into the winter.
“While demand from displacement may recede to some degree as natural gas prices rise, we expect to see a year-over-year increase in weather-sensitive demands with a return to more normal winter weather,” he said.
On the supply side, Eresman noted that North American gas production has plateaued year-over-year, with declines in more mature or conventional basins largely offsetting growth from new plays.
“This year, we’ve seen more than a 50 per cent drop in gas-directed rig counts in North America. And while rig completion efficiencies have improved relative to a few years ago, if this reduced rig–count trend continues, there should be an impact on 2013 natural gas production levels,” he said.
CIBC World Markets Inc. institutional equity research executive director Andrew Potter is in line with Encana’s view for 2013.
Speaking at the annual CFA Society Calgary Oil & Gas Forecast Breakfast, Potter said with current U.S. rig counts the production there will stall at about 65 billion cubic feet a day. At the same time, he said, Canadian deliverability to the United States is expected to decline by about 0.5 billion cubic feet a day by next year.
“You can’t have declining supply and increasing demand and expect the prices to stay static. At some point, the prices have to go high enough to prompt more gas drilling, or see demand destruction,” he said.
Potter said he sees gas prices in the $4 range, assuming there is a normal winter next year, as demand is the limiting factor for the commodity. However, while some might think a modest increase in demand would result in a return to drilling, Potter noted there is currently a lack of rig infrastructure allowing for simply increasing production. To reallocate capital back to dry gas means dry gas developers must compete with tight oil and liquids-rich plays, he noted.
“And the reality is most of them don’t compete until you see a gas price in the $5–$6-per-thousand-cubic-feet range. So we think producers are going to be a lot more hesitant moving back to dry gas than a lot of people in the market do,” he added.
Other major natural gas analysts aren’t so sure 2013 will mark a turnaround in the market. Credit Suisse Group says it expects a pause in recent price climbs due to five mitigating factors.
The first factor is that production from the Haynesville shale play is coming in higher than analysts expected. Rigs have been leaving the Haynesville in droves as low prices have made the play borderline economic. Only 19 rigs were operating there over the summer. Yet production continues rising. Credit Suisse expected July production of 5.9 billion cubic feet per day from the Haynesville but it came in 20 per cent higher at 7.1 billion cubic feet.
The second reason Credit Suisse expects prices to stall is that the industry has become so efficient it takes fewer rigs and completions crews to add to already-huge supplies.
“On a year-over-year basis, the natural gas rig count has declined by 54 per cent, yet production is yet to crack,” the analysts point out. “One of the key factors why production has been so stubborn is the impact of drilling efficiencies. In the Barnett Shale, the industry has averaged 2.70 completions per month, which represents a 17 per cent improvement in efficiencies relative to 2011. This is an astonishing 29 per cent improvement relative to 2010, when the industry completed 2.1 monthly Barnett wells per rig. The same trends are evident in other key dry gas basins.”
New pipelines from the Marcellus shale play in the northeastern United States will also bring additional supplies to market. Credit Suisse says there are 1,000 uncompleted wells in the Marcellus play in Pennsylvania awaiting take-away capacity. Around 500 million cubic feet per day of capacity is expected to be on stream this winter.
A current oversupply of ethane is also adding to supply woes. Around 300 million cubic feet per day of ethane are being left in the gas stream in the United States, says Credit Suisse.
The final concern Credit Suisse has that will limit natural gas price growth is an expected drop in demand from power producers.
“Electric utility demand in 2012 has been off the charts, averaging 5.7 billion cubic feet per day, or 29 per cent above 2011 levels,” it notes. “Using historical correlations between coal-generation market share and gas prices, we estimate the potential impacts to switching at different price points in the first half of 2013. We estimate natural gas could lose 2.4 billion–5.1 billion cubic feet per day of market share to coal at gas prices between $3.50 and $4.50 per thousand cubic feet. At the current futures strip of $3.95 per thousand cubic feet, we estimate gas could lose 3.75 billion cubic feet of market share to coal in 2013.”
Haywood Securities Inc. senior oil and gas analyst Robert Cooper told the CFA breakfast the gas industry is better positioned going into this winter than any time in the last four years. But in the longer term, the Canadian industry needs to reinvent itself.
In the short term, Cooper said the natural gas storage situation has improved greatly this year.
“The withdrawals last winter are quite a bit higher than normal, and conversely, as we got into the summer the injections were quite a bit lower,” he noted, meaning prices should be better.
Cooper also expects the decline in rigs targeting gas in the United States to continue, further dropping supply.
Longer term, he believes the Canadian industry needs to transform itself as the United States moves towards natural gas independence.
“What’s going to happen here—probably within this decade—Canadian naturalgas producers are going to have to find another source of demand,” he said.
If Canadian natural gas suppliers want to continue being competitive in an increasingly energy-independent American market, Cooper said there will need to be a change, and that change will likely come in the form of production for liquefied natural gas export.
“We need to replace probably five [billion] to six billion cubic feet a day of natural gas demand going to the U.S. with an export going to the West Coast. That shift is not going to happen in the next year, but it’s probably going to happen in the next five years,” he noted
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