Sable Offshore Project Hit By More Reserve Revisions

In another sign that Canadian natural gas production may fail to live up to its promise, especially regarding its ability to supply a U.S. market with production issues of its own, the operators of a large offshore project in Eastern Canada have made another in a series of downward revisions to estimated reserves.

The Sable Offshore Energy Project, located off the cost of Nova Scotia, currently represents 3% of Canada's total output of natural gas, but has been plagued by more than its share of production difficulties.

Shell Canada, 31.3% owner in the project and a unit of Royal Dutch/Shell, made its third negative reserve revision in less than three years to the project last week, and Pengrowth Energy Trust an 8.4% partner, Monday made revisions of its own, roughly in line with Shell's.

"I think Sable Island will continue to decline," said Bill Powers, editor of investor newsletter Canadian Energy Viewpoint.

Other partners in the project - estimated when production began in December 1999 to contain 3 trillion cubic feet of recoverable reserves - are Exxon Mobil Corp. , with 50.8%, Imperial Oil Ltd. , with 9.0%, and privately owned Mosbacher Operating Ltd., with 0.5%.

The field's problems may have implications down the road for the extremely tight natural gas market in New England. A report by the U.S. Federal Energy Regulatory Commission in December noted that load factors on gas pipelines feeding New England are likely to exceed 90% for three months in 2004 and that existing Canadian imports to the region can only provide adequate supplies through 2005. The report determined that a combination of LNG and increased production from sources like the Sable project will have to make up for additional regional demand beyond that point.

Shell's revisions to the Sable project's reserves have totaled 690 billion cubic feet so far, with consecutive revisions of 27% in 2001, 11% in 2002 and 40% last week. This amounts to a cumulative revision of just over 60%.

"Shell Canada's reserve writedown was significant - there's no doubt about it, " Powers said.

The most recent revision stems from the fact that the partners have decided not to pursue production at one of what was originally seen as the most promising blocks in Tier 2 of the project, Glenelg, due to a high percentage of water produced.

"The major revision that's come about is because of the Glenelg Field," said Bob Hodgins, Pengrowth's chief financial officer. "We've written it down pretty much in line with Shell," he said, although the company employs independent reservoir engineers and acts on their advice.

Pengrowth's vice president for engineering, Lynn Kis, is philosophical about the declines and points to some encouraging signs as well.

"Reserve estimates change over time - it's just typical for a project of this size," she said. Kis pointed out that the Thibaud and North Venture blocks in Tier 1 have "produced very well" and that the problematic Venture block, which was producing increasing amounts of water, "is starting to stabilize."

Both Kis and Hodgins expect overall production to be stable in 2004 after falling in 2003, because a new part of the field came onstream in December.

Pengrowth has seen its shares decline 20% so far this year. Shares fell 5.5% on Jan. 29, the day of Shell's latest announcement.

Another promising field undergoing development in the region is Deep Panuke, but it has faced its own problems. Equity partner EnCana Corp. asked for a "time-out" in February 2003 for its agreed development schedule due to mixed drilling results, but has resumed development as of December based on two successful wells. Deep Panuke is "a very different kettle of fish," said Penworth's Kis.

Nonetheless, the early results from what energy companies had hoped would be a major new region for hydrocarbon production in Canada haven't been encouraging.

"Offshore East Coast Canada continues to be a challenging environment," Lehman Brothers analyst Tom Driscoll said in a report Tuesday.

Canadian gas production declined 3% in the first 10 months of 2003, with net shipments to the U.S. down 11%, Lehman Brothers estimates. Powers expects a further 5% decline in Canadian production in 2004.

Compounding the supply pinch is the shut in of gas production at some northern Alberta fields to preserve the pressure needed to produce the area's bitumen reserves, the diversion of significant and increasing quantities of gas to provide energy to Canada's large oil sands projects, and rapidly rising local gas demand.

"Unless there are major new gas discoveries made, their natural gas producing regions are likely to decline," Powers said.

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